2 yr ................99 30/32..............4.40%
5 yr ..............100 3/32 ...............4.35%
10 yr .............100 28/32.............4.38%
30 yr ..............112 15/32 .............4.53%
The above chart is the price quote for the U.S. Treasury bond market for December 30, 2005. The third column to the right denotes the bond yield percentage.
There are a couple of things that should jump out at you.
The first is that despite the fact that we are at war in two countries, we have a large balance of payments deficit and we are running pretty significant budget deficits, yet the yield on the thirty year Treasury bond is at 4.53%.
By historical standards this is below average and by itself would indicate a couple of important things. First and foremost is that people who buy this investment instrument continue to believe that it is the safest fixed income vehicle in the world, that the 4.53% yield meets expectations over that length of time and that most importantly, inflation is sufficiently controlled as to make that yield attractive for continued investment.
The next item of interest is that the two year yield is at 4.40 which is higher than both the 5 year and ten year bond. This is called inversion of the yield curve. Since the 30 year is only 13 points higher than the 2 year it is also possible that the two might invert against the 30 as well.
The significance of this as a harbinger of economic events to come should not be over looked. The last five recessions in the United States have been preceded by this event. This in and of itself is not the sole factor in an economic slowdown however by its appearance so frequently before bad turns for the economy it should not be downplayed.
The most recent occurrence was in 2000. The Fed operating under the perceived threat of inflation continued to ramp up short term rates up to near 6.50% until eventually the short yield inverted against the thirty year bond by almost 50 points. The recession that followed forced the Fed to reverse policy and they frantically began to cut rates to again re-invigorate the economy. The whole process was exacerbated by the events of 9/11.
With the U.S people and economy in shock, the Fed reacted by reducing short term rates to levels not seen in our lifetime. The results really should not be a shock to any of us. The availability of very cheap money spurred a housing boom that resulted in more people in all economic strata owning homes than anytime in American history. The low cost of money also spurred a significant increase in all forms of American consumer debt. Home mortgages, car loans and the despicable credit card debt have all sky rocketed.
The inversion of the yield curve is an ominous development for those people who took advantage of those low prices for money but for reasons unknown did not lock those low rates in.
Just as there was an enormous boom in these areas we may now be likely to experience an enormous bust. With variable rate debt vehicles rising with each Fed increase in short terms rates the monthly debt repayment burden has increased on the American consumer. Soon to be instituted minimum monthly payment increases on credit card debt will only exacerbate this problem.
If the Fed continues to raise rates the impact will reverberate throughout the US economy. American auto makers are teetering on disaster and rising rates have contributed to that problem. The housing market over the past two months has shown significant weakness and mortgage default is up. A trickle will turn into a torrent if the Fed persists.
Alan Greenspan has been widely praised for his management of the nation’s monetary system since his rise to the post of Chairman of the Federal Reserve. It would be a shame that on his way out the door, his lasting legacy is one of a significant economic bust precipitated by an over aggressive Fed worried about non existent inflation.
