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Permanent flattening of the yield curve?


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February 15, 2007

Permanent flattening of the yield curve?

Michael Mandel

In yesterday's Q&A before the Senate Banking Committee, Bernanke talked about "a somewhat permanent flattening, or even inversion, of the yield curve."

That fits right into the argument in last week's cover story on low rates.

10:46 AM

Financial markets

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When everyone starts agreeing that a particular economic trend is here to stay, and they start acting on that belief, isn't that often when things begin changing?

Posted by: Lew at February 15, 2007 08:08 PM

The link didn't work for me but I want to say that I think it is dangerous to see any economic cycle as ending. I don't think we can control any economic cycles completely. I also don't think we will "enter into a new era with new rules." Haven't we heard that before? The only thing we can control is inflation but I don't see that as a cycle. I think cycles of prosperity last longer today than they used to because a larger portion of the population has more than they need so survive than in years past. Early retirement is an option for many who get put out of work. These people continue to consume even though they aren't working. This slow down of interest rate volatility is just the result of individual stability. In time, I'm sure rates will fluctuate again.

I'm an optimist by nature but I see serious problems with recovery from the next recession. We will need a heavy investment in robotics and other forms of productivity improvement in combination with a large immigrant population. Maybe some baby boomers will be lured out of retirement by high wages to cushion the impact.

What impact do labor supply issues have on interest rates?

Posted by: Joe Cushing at February 19, 2007 02:45 PM

The link didn't work for me either but we should be mindful that flattened yield curves aren't without precedent. If you analyse european interest rate data back into the 1800s and early 1900s(yes it exists!) there were prolonged periods where the spread between the short term and long term cost of money was very narrow. True this was a different era with very different capital markets dynamics but it was also a period where we had significant and comparatively unencumbered flows of international trade and one where prices increased very little. In the UK prices between 1820 and 1900 remained flat - falling in some years and rising in others.

Posted by: Simon at February 20, 2007 10:58 AM

As I see this. There appear to be tens of trillions now invested with the idea that there will be lower cost products and services as a deflationary force worldwide. That costs for labor and even commodities that could disrupt this worldwide deflation are being seen as only localized or limited time events that will not permanently disrupt this base. Again tens and maybe hundreds of trillions seem to support and demand lower level rates for the next two decades.

Posted by: Mike Reardon at February 20, 2007 02:01 PM

Here is the corrected link:

http://www.reuters.com/article/economicNews/idUSN1435740020070214

And here is the full quote from Bernanke:

"Just very quickly, though, on the forecasting power of the yield curve, there's been a good bit of evidence that declines in the term premium and perhaps a great deal of saving, chasing a relatively limited number of investment opportunities around the world, have led to a somewhat permanent flattening, or even inversion, of the yield curve, and that that pattern does not necessarily predict slowing in the economy or a recession. Indeed, if you look at other measures of financial markets, such as corporate bond spreads, you don't see anything that suggests anticipations of future stress."

I do love that phrase, "somewhat permanent." Only a Fed chairman could get away that degree of euphemism. Actually, I honestly think he mispoke and meant to say "persistent", meaning that it is not expected to stay permanent forever, and really is "transient", but has persisted for longer than theory normally permits transient "events" or "episodes." Whether the flattened or even inverted yield curve "persists" for a few more months, six months, a year, or even two or three years, the global economic landscape is evolving in ways that are not fully predictable, and that "will" affect the yield curve, not to mention its "significance."

"Somewhat permanent"? Hmmm... Maybe that corresponds to the length of a Fed chairman's tenure.

-- Jack Krupansky

Posted by: Jack Krupansky at February 22, 2007 11:01 AM

The creation of financial instruments is only going to continue its increase as the skills to employ more assets are gained by developing socialist markets with balance of payments reserves to invest. This becomes the next logical step and it also creates even more cheaper cash in the financial system. Nothing is going to stop this cheap investment money removing pressure by markets to obtain cash for investment that would push up rates.

The Associated Press March 10, 2007, China forming fund to invest reserves. By Joe McDonald

http://www.businessweek.com/ap/financialnews/D8NPJLD00.htm

I've said before that our debt service may be directed by China and India to other developing nations for their commodities. The question is can China gain a premium by trading our debt directly to another nation for their commodities. We could end repaying not China but Chad for past US government bonds. China may have even deeper investment reserves.

Posted by: Mike Reardon at March 10, 2007 07:34 PM


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