Inverted Yield Curve

The yield curve has now officially inverted. That means that short-term interest rates are now higher that long-term interest rates, at least for some maturities.

An inverted yield curve is very often a signal of an upcoming recession. But in the topsy-turvy world of finance, there are always those who prefer to stick to their own preconceptions than listen to a reliable indicator.

So, predictably, the headline in today's Wall Street Journal is "Economists Question Bonds' Predictive Power: Economists are questioning whether the bond market's yield-curve inversion presages a downturn."

This sounds vaguely familiar. When have I heard that before? Oh yeah, in 2000, the last time the yield curve inverted, the headlines were about how it was all different this time. The stock market had had a huge runup, the federal government was running a massive surplus (remember that?), and so there couldn't possibly be a recession coming.

We all know what happened next.

In truth, the Wall Street Journal article is much more balanced that the headline--for example, the reporter points out that a yield curve inversion has only been a false signal twice in 50 years, and one of those two false signals was due to the collapse of Long Term Capital Management in 1998 (which actually could have led to a recession, if it hadn't been managed better).

And it is possible that this time around will be different.

But I wouldn't count on it.

You should assume that there very probably will be a recession between now and the end of 2007. Anything else is just wishful thinking.