To: Tommaso who wrote (68231 ) 8/15/2006 5:48:42 PM From: ild Read Replies (1) | Respond to "Such (yield curve) inversions are about as rare as a solar eclipse. But when they have occurred, they often have been harbingers of recessions and bear markets. Small wonder an inverted yield curve strikes terror in the hearts of economic forecasters and investors. How worried should we be? Is today's inverted yield curve an omen of disaster? I think not, based on the factors that determine the yield curve's shape, and the evidence -- or lack thereof -- of the curve's power to predict economic activity ... But why should interest rates fall? There are two possibilities, one a cause for concern, the other quite benign. Rates might be expected to fall because a recession is on the horizon. In a recession, loan demand falters and the Federal Reserve can be expected to lower rates to stimulate the economy. This scenario gives a justification for believing that an inverted yield curve augurs recession ahead. But there is a far more benign reason for expecting lower rates in the future. Investors might believe, quite reasonably, that a cooling off of the hot energy markets and the diligence of the Fed will keep inflation in check. Lower inflation could lead to lower interest rates in the future, and lower rates under noninflationary conditions could permit the economic expansion to continue without interruption. Thus, an expectation of falling interest rates need not imply that a recession will follow ... If confidence in monetary policy has increased, however, the risk premiums demanded by bond investors will decline, making it more likely the curve could invert. If lower risk premiums are at least partly responsible for the shape of today's yield curve, investors have no reason to fear a recession from an inverted curve ... Admittedly, an inverted yield curve has preceded all recessions over the past 40 years, and it is foolish to dismiss time-tested signals. But the signal is not invariably correct. It has predicted eight of the past six recessions. The two times in 40 years that the yield curve got it wrong were periods of relatively low interest rates. The curve inverted in late 1966 when long rates were around 5%, and no recession followed. The curve inverted again in late 1998, with long bonds generally yielding 4.5% to 5% ... To be sure, an often effective forecasting signal can never be ignored, and this is a time for caution. But investors should not be spooked by an inverted yield curve. Current monetary conditions will not impede economic growth, and there is no certainty trouble is near."
