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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (53690)	2/13/2006 11:43:33 AM
From: ild	Read Replies (1) \| Respond to of 110194

Berson's Weekly Commentary Economic Commentary February 13, 2006 Is the shape of the yield curve telling us that there will be a recession in 2007? The yield curve shows the relationship between yields on assets with similar characteristics, differing only in their term to maturity. For example, the Treasury yield curve shows the yield on riskless Treasury securities with maturities ranging from one month to 30 years (at least as of February 9th following the first auction of the newly re-instituted 30-year Treasury bond). This yield curve has been an important tool in projecting economic downturns in the past, as all of the post-war recessions have been preceded by an inversion of the yield curve. Normally the yield curve is upward sloping (i.e., yields on short-term rates are lower than those on long-term rates), but occasionally this relationship reverses and the yield curve is then said to have inverted. The chart below shows the Treasury yield curve as of Wednesday, February 8th. The current yield curve is slightly inverted over much, but not all, of its range. Yields on one-month and three-month bills are less than those on six-month bills, while the 10-year yield is slightly above that for those notes with a five- or seven-year duration. But, many analysts look at the spread between ten- and one-year Treasury securities to get a shorthand measure of the shape of the yield curve -- and on this basis the yield curve is inverted, as that spread was -10 basis points. Looking at the past eight recessions (back to 1957), the average length of time between the yield curve inverting (using the ten-year/one-year spread) and the beginning of the next recession averaged nearly 12 months -- although it ranged between 7 and 20 months. Does this mean that the economy is poised to slip into a recession next February (or between September 2006 and October 2007)? At this point, we would be very hesitant to make such a strong claim, for several reasons: First, not all yield curve inversions have been followed by a recession (although all modern recessions have been preceded by yield curve inversions). The yield curve inverted for 15 consecutive months from late-1965 to early-1967 without a subsequent downturn. (Note that the yield curve inverted again beginning in 1968, and the 1969-70 recession followed). Second, long-term Treasury rates may be held down by special factors today. Among these factors are continued unprecedented foreign demand for U.S. dollar financial assets, relative supply shortages of longer-dated Treasury securities, and continued low inflation expectations. Third, past yield curve inversions preceding recessions have been longer lasting, more severe, and more complete (that is, the yield curve inverted over its entire length) than the current episode. If in the near-term short-term rates should fall relative to long-term rates, or long-term rates should rise relative to short-term rates, then the yield curve would regain its usual upward sloping shape and recession concerns should abate. But if the Federal Reserve continues to tighten monetary policy and if long-term rates are relatively stable, then the yield curve could invert more steeply and over its entire length. At that point concerns about a downturn in 2007 will intensify, and discussions about whether conditions really are different this time (see points one and two above) will also increase. We are lowering our projections of 2007 real GDP growth because of the yield curve, but at this point it still looks to us as if the economy will slow modestly rather than more significantly (or fall into recession). As a result, we expect 2007 to be a year for a soft landing. After a paucity of economic data last week, this will be a very busy week for economic indicators. On Tuesday, retail sales for January are projected to increase by 0.9 percent and by 0.8 percent excluding autos -- indicating that consumer spending is likely to accelerate this quarter. Also on Tuesday, business inventories are expected to rise by 0.3 percent in December -- a modest slowdown from November’s pace. On Wednesday, the New York Fed Empire State Manufacturing Index should edge down to 18.5 in February -- the lowest level in four months. Also on Wednesday, industrial production is projected to be unchanged in January while capacity utilization should slip to 80.6 percent -- because of a drop in utility output in response to the warm temperatures last month. Additionally on Wednesday, the monthly builder survey from the National Association of Homebuilders (NAHB) should be little changed at around 56 in February -- the lowest level in three years. On Thursday, housing starts are expected to rise to 2.04 million units (annual rate) -- in response to unseasonably warm weather, not an improvement in the underlying housing market. Also on Thursday, the Philadelphia Fed business outlook survey should rise to 10.0 in February -- after its surprising January drop. Additionally on Thursday, import prices are expected to climb by 0.7 percent in January -- in part from the rebound in oil prices. Finally on Thursday, initial unemployment claims should edge up to around 280,000 for the week ending February 11th -- continuing to reflect a strong job market. On Friday, the producer price index for January is projected to increase by 0.2 percent, with the core rate also up by 0.2 percent -- as the recent jump in oil prices won’t be seen until the February report. Finally, on Friday, the University of Michigan’s preliminary February figure for consumer sentiment is expected to be little changed at around 92.0 -- suggesting modest increases in consumer spending in coming months. David W. Berson Fannie Mae Economics fanniemae.com