Yield-curve critics say there are better leading indicators for a recession, such as housing permits (which tend to peak 17 months before the recession starts) and consumer confidence (which dips 3 to 9 months ahead of a downturn).
What could be worse than the Fed's flattening the yield curve and stoking 1970s-style inflation?
It is unnatural to have interest rates close to zero and to distort the yield curve by pegging longer-run bond prices at artificially high levels and suppressing yields.
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In others it may be because central banks have rigged the yield curve, holding short-term rates artificially low and inducing banks to make money by buying longer-dated government bonds.
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Pegging the federal funds rate close to zero for another three years and twisting the yield curve to lower longer-term rates will continue to misprice credit, penalize saving, and encourage risk.
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But according to Takuji Aida, an economist at UBS in Japan, long-term yields remained very low because of deflationary expectations, thereby flattening the yield curve (the difference between short- and long-term interest rates).
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There could be trouble ahead for another increasingly popular yield vehicle, mortgage REITS. If the Fed implements Operation Twist and buys long-term bonds to flatten the yield curve, that could hurt leveraged investors in mortgage-backed securities two ways.
This has led to an oddity what is dubbed an inverted yield curve: yields on long-term bonds have fallen below those of shorter-dated ones (which have barely budged).
Like many an economist before him, Bernanke seems to have downplayed a telltale omen: the inverted yield curve, in which short-term rates on Treasurys exceed long-term rates.
But on May 15th the short-term yield curve turned positive for the first time in 16 months, usually an indicator that the market thinks enough easing has taken place.
There have been many recent recommendations to extend out along the yield curve given the municipal yield curve is approaching historic highs (401 bps 1-30yrs ).
The difference between short- and long-term rates, otherwise known as the yield curve, is close to historic highs, even though long-term rates have fallen remorselessly over recent years.
Remember that interest rates rarely shift up in a parallel fashion, so the yield curve will probably flatten, with longer-maturity yields rising by less than one point.
Savings and loan institutions, recent victims of the flat yield curve with huge redemptions in outstanding fixed-mortgage paper, will be able to operate at wider spreads.
Considering that quantitative easing is effectively the same as an interest rate cut below a zero bound, the yield curve is very steep even with 10-year yields just below 2%.
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Implied yields on 90-day bill prices slipped by three basis points along the curve and the lower yield environment spread to the long end where benchmark 10-year yields dropped by three basis points to 5.45%.
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For now, the historical euro risk-averse sanctuary remains at the very short-end of the German yield curve.
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These bonds are priced on top of the 30 year triple-A curve at a yield of 4.40%.
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In both Europe and America, banks have seen their margins squeezed as the yield curve has flattened, thanks to rising short-term rates.
The other, UltraShort Lehman 7--10 Year Treasury (72, PST) , does the same for the 7- to 10-year part of the yield curve.
It drives short-term interest rates lower allowing banks to borrow low on the short-term end of the yield curve, and lend high on the long end.
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Currently, the Treasury yield curve ranges from 0.11% for 3-month T-bills, to 2.85% for 30-year T-bonds.
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By keeping the yield curve flat, QE2 pressures banks to make more higher-return loans as investing in treasuries and short-term facilities provides a lower and lower profit margin.
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But the Federal Reserve had already started raising short-term interest rates, flattening the yield curve, the difference between short and long rates. (Since banks borrow short and lend long, their margins are higher when the curve is steep.) When this began eating into lenders' profits, they reacted by pushing subprime rates back up.
The yield curve is flattening in America (the gap between the short-term federal funds rate and yields on ten-year Treasuries is only a smidgeon more than one percentage point) and in Britain it is inverted (long bonds yield less than shorter ones).
Institutions are also nervous, as very short-term T-bill rates have spiked, therefore causing the yield curve to flatten out.
When savings rates rise, but savers hoard, rather than invest, the central bank pushes its newly created money out of short-run credit markets and out into the whole yield curve.
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