interpreting yield curve.

Hi, I was looking at the yield curve over the last year and was noticing it move from a flat curve in Sept and Oct 07 to a slight inversion at around the 2 year maturity mark. Would that support the indication of expected recession? After that the yield curve steepens quite a bit. In normal instances it seems that would support expected expansion and the wish to not be locked in at lower yields for longer periods. But this steepening seems to suffer more from a plunge of short term yields and a flight to safety in the current environment rather than a rosey outlook of the future. I guess it can still support expected expansion if the market believes the bottom is near. Am I interpreting this right? Appreciate any insight. Thanks, Shab

I guess you are on the right track. I don’t’ remember seeing the Yield curve from Sept, Nov of last year but yes we were almost at the time when the markets had began to expect the fed to start cutting rates to boost the economy and the market had put that into its expectations - which ultimately happened. In other words yes it was a sign of a decrease in growth (not necessary a recession in technical terms). A rise in the Yield curve that you see for longer maturities is really due to 2 factors 1) expected inflation 2) risk premium that long term investors expect. In general the markets can’t predict economic condition more than 2 years out so higher interest rates beyond two years cant really predict economic expansion. According to the current yield curve rates 2 years out are still less than 2% - given that I won’t say the market believes the bottom is near.

Thanks for the input. Could not the rise in the curve actually be the result of 3 factors (inflation, risk and an unusual pressure downward on ST yields due to the crisis). I think the steepness in the recent yield curve (in addition to expected inflation and risk) is also a result of the steep decrease in short term yields as a result of the “flight to quality” given the recent crisis. Moreso than in normal cycles. The demand of short term treasuries has really pressured the yield down while the risk premium has kept the longer term yields higher resulting in a steep curve. Agree?? Disagree?? Shab

Aren’t you discussing the yield curve that existed a year ago? Why would our current problems be reflected in that?

Yes and no, I was trying to interpret the yield curve and it’s changes over the last year up until it’s recent shape. More of the story it tells over the last year starting off as flat and morphing into the steep curve you see today. When talking about the steepness of the curve, I was addressing the current curve (and the current situation) and wondering if it’s steepness is more of a testimony of the current Short Term demand (given it’s very low yield and high demand as a result of the current crisis) or of the risk and liquidity premium of LT demand. It would seem to me that a steep curve would indicate some level of expected growth (i.e. coming out of a recession), but would that be the case given the current circumstances The curve of a year ago was mostly flat with some inversion around the 2 year maturity mark so I was asking if that was signaling slow growth and a possible recessional indicator. Kind of two part question. Sorry for the confusion.

Current yield curve is surely all about the short-end. These are historic times for T-Bills (negative yield at one point last week). Not sure about the 2-yr thing one year ago. Seems lost in the haze of really dramatic events lately.

Thanks Joey, That’s what it seemed like to me. Steepness from the pushing down of ST yields given the crisis moreso than the expected increase of future yields.

Of course the ST yields are low due to the market conditions and that has made the curve steeper, that’s basic geometry. But if you compare Longer Term rates from last year to today those haven’t dipped as much (hovering around 4%) . My comment was addressing your question about those higher rates indicating economic expansion and my answer is No - those rates are higher only because of the risk premium and expected inflation over current rates.

Thanks Axl, I didn’t to come off as disagreeing with you because I’m not. I agree with your assessment of the LT rate expectations. I was just looking to confirm if the current ST situation is a primary component of the current steepness of today’s curve. Again, thanks.