Dec 27 2005
Inverted Yield Curve
For the first time in five years, the US Treasury yield curve inverted, with two-year notes yielding more than ten-year notes. In the past, yield curve inversions have predicted economic downturns four out of five times. As a result many people feel that this is indicative of a potential slow down in the US economy next year.
However, many people believe the yield curve inversion is not indicative of an economic downturn. An increase in savings around the world has lead to a higher demand for US Treasuries, especially the ten-year note. This increased demand is the cause for the inversion. As a result of the increase demand, the yield curve could be implying that the Federal Reserve’s policy of increasing leading rates may be complete.
This inversion is not a huge problem at the moment, because the inversion is fairly small. The spread between the two and ten year notes, seen as a proxy for the whole yield curve, oscillated between positive and negative throughout Tuesday, falling to a low of negative 1.4 basis points. By the end of the day, the spread was only 0.4 basis points. If this inversion continues, or gets larger, we may have problems, but there is nothing to worry about at the moment.