Alan Greenspan called it a conundrum. Earlier this decade, the long-term rate of interest in the US fell below the short-term rate. This is known as an inverted yield curve.
Previously, this often happended soon before a recession. But at that time no one was suggesting a US recession was likely. This is why the maestro called it a conundrum.
Actually, the explanation was quite simple, and Mr Greenspan understood it. Savings rates were high in countries such as China and in the OPEC countries, and the money was flowing into US coffers.
In a way though, the inverted yield curve of that period was an early indicator of the problems that were building – and have manifested themselves in today’s credit crunch.
This is all quite interesting because, in the last few days, the UK has also witnessed an inverting yield curve. Does it mean recession is around the corner?
Well, perhaps. It is true this is not an infallible measure, but as Paul Dales at Capital Economics says, “The recent news on activity suggests that the economic slowdown is gathering pace. Most notably, the housing market appears to be going from bad to worse and the fall in the business activity index of May’s CIPS/RBS services survey suggests that this weakness is spreading to other parts of the economy.
“And the fact that inflation fears are likely to prevent the MPC from cutting interest rates again soon will exacerbate the downturn in activity. We currently put the odds of a recession at around one in three. But the longer that the MPC leaves interest rates at 5 per cent…the greater the chances that the economy will enter a recession.”
As for that barometer, the yield curve, Mr Dales added, “With inflation fears likely to mean that interest rates remain on hold for some time yet, further rises in short bond yields could result in a more marked inversion of the yield curve.”
Comments
Trackbacks