Monday, June 1, 2009

Typically, a steep yield curve is a sign of a strong recovery, but there is nothing typical about current monetary policy.

From Antonio Fatas and Ilian Mihov on the Global Economy:

The yield curve and the credibility of central banks

An increase in the yield for 10 year bonds put the yield curve in the US at one of its steepest since the mid-70s raising concerns about the evolution of long-term interest rates and the effect that they might have on the economic recovery. From Bloomberg, you can see that there are two ways to interpret the increase in the yield: Timothy Geithner thinks this is a good sign

Geithner also said that the rise in yields on Treasury securities this year “is a sign that things are improving” and that “there is a little less acute concern about the depth of the recession.”

Others see this as a sign of concern

Gross said in an interview today on Bloomberg Television that
while a U.S. sovereign rating cut is “certainly nothing that’s going to happen overnight,” financial markets are “beginning to anticipate the possibility.”

Typically, a steep yield curve is a sign of a strong recovery, but there is nothing typical about current monetary policy. Here and here are two blog entries that discuss the recent steepness of the yield curve in the US.

One thing that I find interesting is that despite the uncertainty surrounding the current economic situation, the yield curve is almost identical in the Euro area (Germany), the UK and the US (see chart below). This means that not only the perception of a default risk for these three government is similar, which is probably a reasonable guess, but also that inflation expectations are almost identical for the ECB, the Bank of England and the Federal Reserve.

While it is difficult to imagine circumstances where the inflation rates in these three areas deviates by a large amount, it is not that unlikely to build scenarios where inflation differentials are larger than the ones implied by those yield curves. Given the uncertainty and the difficulty predicting which ones of these scenarios will prevail, the yield curve seems to be anchored by the assumption that the three central banks will adopt very similar policies and will deliver an almost identical inflation rate. That's a strong sign of confidence on these three central banks.

Antonio Fatás"


Don said...

From my point of view, this is how you want QE to work against Debt-Deflation, which is a panic phenomenon.
1) Low Short Term Interest Rates, as a disincentive to buy guaranteed assets, and an incentive to buy stocks and corporate bonds. This attacks the Fear and Aversion to Risk.
2) Rising Longer Term Interest Rates, which signal an end to Deflationary Fears, and are an incentive for Longer Term Investing.As well, as you say, the Spread often ( which is as exact as this gets ) signals a recovery.

Now, what's interesting, is that I take it that this is what Bernanke and Geithner have been arguing, although not necessarily saying it the way I do. And, in fact, it seems to be working, which , again, is about as good as it gets, since none of us know the future.

Yet, as obvious as this is to me, others have been puzzled by this line of reasoning. I, on the other hand, do not understand the point of having interest rates move in tandem, insofar as incentives are concerned.

I understand the idea of rising interest rates being a problem, but the Fed has other means of addressing mortgages, in coordination with other parts of the government. However, I am not for keeping interest rates of mortgages artificially low at all, but certainly feel that this policy should now end. We need to see a plausible bottom on housing prices, without the perception of government still keeping housing prices artificially high.

Don the libertarian Democrat

Of course, Inflation will be the issue going forward, but I prefer that to a Debt-Deflationary Spiral. Call me silly, I guess.

June 1, 2009 2:14 PM

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