style=”color:#35;666666;”gt;Not so long ago, the then Fed chairman Alan
Greenspan said he had a conundrum. The US economy was booming, all the
reports indicated the good times would continue, and yet#133; the short-term
rate of interest, typically set by the Fed, and the longer term rate, set by
markets, were converging. A phenomenon known as the inverted curve, was
emerging, and economic history tells us that inverted curves mean recession
ahead. But this was at odds with all the positive economic news, and
therefore, many of the experts argued, the inverted curve was an anomaly -
nothing to get too worried about.
Forward wind the clock just a few months to today and all of a sudden
the view looks different. When markets tumble, economists fret. Fears over
the resurgence of inflation, coupled with concerns that the US balance of
trade deficit will unravel are behind the recent market turmoil.
If the curve representing the difference between long-term and short-
term rates were to invert today, that would be a lot more worrisome. Here’s
the bad news. Yesterday, albeit for a short time, that’s precisely what
happened.
At the end of 2000, long-term rates moved below the short-term level,
and stayed there for around 11 months. Recession followed. But this time
around things are a little different. The inversion we saw a few months ago
was short lived; yesterday, the inversion lasted a matter of a few hours. It
went negative on news of a dip in sales of big ticket items, such as cars and
fridges, but on the release of another report showing good news in the US
housing market, the long-term rates went up, and normal relations between
short and long-term were resumed.
So, around ninety minutes of an inverted curve does not mean recession
ahead. The fear is that this will happen again, and then again, and it will
settle at an inverted point for a while.
Why is this serious? Banks and other lending institutions typically
borrow at the long-term rate and lend at a level that is commensurate with
the short-term rates. So an inverted curve could spell a shortage of
credit.
Why is it possible this won’t matter? Firstly, the Fed has been upping
the interest rate so quickly of late that it is, perhaps, hardly surprising that
markets have not kept up. Secondly, the rate of interest is much lower today
than in the past when rates inverted, leading some to speculate that this
time around an inverted curve won’t matter.
Either way, this is a story that will unravel as the months move on - and
if nothing else, the saga could make the rate of interest interesting.
Sources
Yields throw the Fed a curve CNNMoney
This time, inverted yield curve may signal US slump
Reuters
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