Wednesday, January 19, 2011

A Yield Curve Risk

June 24, 2010
Is the US yield curve losing its ability to forecast recessions?

In the early 1990s, when Japanese rates were generally at a higher level, a yield curve inversion signalled a period of oncoming economic weakness. However, since 1995 the BOJ target rate has never exceeded 0.5%, during this time Japan has entered 3 defined recessions, however the 2 year 10 year yield curve has not even come close to zero.

There's a nice chart of this on that blog. Japan has experienced an upwardly sloping yield curve (just like our current one) since their housing bubble burst roughly two decades ago.

I am not comparing the US economy to the Japanese economy, I am however pointing out that a prolonged period of low rates can reduce the ability of the 2 year 10 year curve to predict future economic activity.

I think this is a serious risk and I would like to once again bring up the chart I posted yesterday with some visual enhancements on it.

Note that our 3 most recent downturns required an amazingly long period of extreme accommodative Fed policy (compared to previous downturns). Should this trend continue long-term we might actually end up in a situation where we require an infinitely long period of accommodative Fed policy someday. We might be in such a period right now. Who knows?

Is our economy truly self-sustaining right now? If the Fed announced that they would end their assistance of this economy right now and let the natural market forces take over then what would happen on Wall Street? My guess would be sheer panic. I'm talking biblical fire and brimstone level panic.

This post inspired by a
comment left for me on the TLT thread.


watchtower said...

"I'm talking biblical fire and brimstone level panic."

But not to the point of "Human sacrifice! Dogs and cats living together! Mass hysteria!" though, right?

I don't know if I'm kidding or not because I believe all the above and then some if the Fed stepped back.

Excellent post, your graphs (as usual) always helps me to grasp things a bit more than I normally would.

Mr Slippery said...

No way this economy is self sustaining with Fed and deficit support. GDP about 3%, budget deficit about -10% of GDP so you take the deficit spending away and we are immediately at -7%. And the cool thing is, we are not even borrowing money from foreigners, the Fed is printing about half of it out of thin air. It will take massive cuts in Medicare and military spending to get back into balance and/or massive tax increases. Good luck to us all.

Mr Slippery said...

Ack! No way this economy is self sustaining without Fed and deficit support.

Stagflationary Mark said...


I was indeed thinking Ghostbusters when I wrote that. Hahaha! :)

Stagflationary Mark said...

Mr Slippery,

CNBC listed off the top 10 holders of our debt today. The Fed came in at #1.

Erin Burnett was thrilled that China wasn't #1. We hold most of our debt. Americans! Hurray! ;)

G.H. said...

OK, we've discovered that present and future retirement plans, that is, pensions, both public and private, are erroneously based upon the great American Ponzi system.

And we've begun the work of ending these benefits to workers who simply agreed to an agreement to receive future payments after their working days ended via their contract for employment.

So, in retrospect, it's just fine if you happened to be one of the few who cashed out on the Ponzi that included periods of stock market and real estate mania.

Now, where are the MSM reports notifying the rest of the world that our future is, well, any color but bright?

I say let's accelerate this f'ing race to the bottom by deleting SSA immediately, reneging on all past and present pension promises, public and private, and start setting up the NRL (National Rollerball League).

"After much personal introspection, and further delving into the true nature of the corporations that run the world, Jonathan decides he is going to play in the game despite the obvious dangers."

"P.A. Announcer: Ladies and gentlemen, will you stand please for the playing of our Corporate Hymn."

Word ver. - "slacqu". Slack you too!

Stagflationary Mark said...


Now, where are the MSM reports notifying the rest of the world that our future is, well, any color but bright?

I found one here.

Well, there is "dark" in the title. That's about the best I can do, lol.