Tuesday, December 27, 2005

Inversion: should we worry? 

The yield curve on Treasury securities inverted today, meaning you got a higher rate of return on a two-year note than a ten-year note. Ten-yeras are typically .9% higher. Should we be concerned? Opinions differ:

Bear Stearns Cos. expects any inversion to last ``several'' months, according to David Boberski, head of interest rate strategy at the New York-based firm.

``It will stay inverted until it's clear we're at the peak of the business cycle and rate hikes are done,'' Boberski said Dec. 20. ``Whether we're coming up to that peak in the next few quarters is unclear.''

An inversion would still likely be viewed as an ``ominous sign'' for the economy and be followed by an economic slowdown, or even a recession, said Tony Crescenzi, a bond strategist at Miller, Tabak & Co. in New York.

He wrote a book called ``The Strategic Bond Investor'' and taught classes on the bond market at Baruch College's executive MBA program.

Fed Chairman Alan Greenspan said in congressional testimony in July that there is ``a misconception'' of the importance of the yield curve. The curve's ``efficacy as a forecasting tool has diminished very dramatically.''

The Bloomberg article shows five inversion periods since 1980. A masters thesis I just supervised supports Greenspan's view -- the yield spread's predictive powers have diminished since the 1970s. James Hamilton thinks differently.

David Altig looks at Fed Funds futures markets and thinks the Fed may be done raising short-term rates. Are they moving to neutral too late to avoid a recession later this year? Our new Quarterly Business Report from SCSU shows local businesses are pretty optimistic that 2006 will start off strong. I don't think this inversion is a sign of an upcoming recession ... but it bears watching.