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By New_Deal_democrat June 13, 2017 10:40 am
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Waiting on the yield curve

As I wrote last week, nobody should ever rely on a single indicator to forecast the economy.  There is always some indicator that at any given time is consistent with a recession.  Even those that are most reliable occasionally have a misfire.or at very least a near miss.  Finally, an indicator that might be reliable in one set of circumstances might not do so well in another era.

Thus, as I wrote last week with regard to the yield curve, in the deflationary era of the 1930s into the 1950s, it was not necessary to have a yield curve inverstion to have a very severe recession, e.g., 1938.

That being said, if there is an outright yield curve inversion, it has almost always meant trouble, even in deflationary times.  This was most famously the case in 1929:

I would also include 2006-07 in that category.

Since we are in a similar deflationary era now -- absent housing (owners' equivalent rent), consumer prices have been running at 0%-1% inflation for several years:

I would take a yield curve inversion now as being particularly ominous.

So how close are we?

Stockcharts.com has a particularly nice graphic called the Dynamic Yield Curve, which allows you to see the yield curve move through time, and to take snapshots of several points.  I've made several such snapshots.  In each the lighter red is the yield curve as of last week.

First, here is a comparison with last July, when long term rates hit their lowest point in decades:

Note that the slope of the curve is very close to what it is now, just lower across the board, suggesting that the bond market sees more future inflation now than it did last year.

Now let's compare the end of last year, after the US Presidential election, with the present:

Note that in the 0 to 10 year time frame, the curve was much steeper. The bond market is forecasting a weaker economy now than it was six months ago.

In the face of the last two Fed funds rate increases, the long bond has declined slightly in yield.

Almost everybody expects the Fed to hike rates again on Wednesday. If yields behave the same as they have in the last six months, expect a further flattening of the curve although not an inversion.

But this is probably the last time the Fed is safe hiking rates without causing an inversion.  Even with a 1.5% Fed funds rate, I would start to be very worried that an inversion could happen at least at the short end of the spectrum.

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