Inverted Yield Curves Around the World

Long-term Trend Watch:  Econbrowser discusses the predicitve power of inverted yield curves with respect to recessions, and decides that the jury is still out.  I have noticed that the UK and Australia have had inverted curves for years apparently without effect, and the US just had one that has since steepened.  They also notice that the EU has recently acquired an inverted curve.  My understanding is that inverted curves were more common back in the 19th century, back before central banks were as powerful as they have been in recent times.

It could be that global capital markets are now swamping the central banks in those nations that are the most open to foreign capital flows (i.e. the Anglo-Saxon countries and the EU).  Long-term rates are more anchored and the short part of the curve fluctuates from slight a upward-slope (during a period of accelerating growth) to a slight downward-slope (during a period of slowing growth). 

I have long believed that the Fed’s big monetary mistake in the early 2000’s was not lowering the rate to 1%, which was a necessary risk-management move to fight the threat of deflation (remember how strong the dollar was at that time and how low the price of gold was).  The big mistake was not raising rates faster when the 10-yr spiked to 4.80% in the matter of weeks.  The signal sent by the incredibly steep curve was that the financial markets had loosened and growth would accelerate, but the Fed kept pumping money anyway.  It should have responded to the market signal and raised rates into the low 3% range a bit faster and moved the curve to a moderately postitive slope (provided the long end behaved appropriately).

Right now the signal the market is sending is that the Fed should lower rates to the 4.00%-4.25% range.  If the long bond yield continues to spike up, then it can take away the cuts just as quickly.

Yield_curve_101507

[Click to enlarge]

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