Long versus Short Term Yields
If we plot the yields (or interest rates) for various maturities of
U.S. Treasury bills/bonds on a graph, you see the chart begins on the left with the shortest maturity
(three-month T-bills) and ends on the right with the longest (30-year Treasury Bonds). This is the Yield Curve.
Normally, as the time to maturity increases, the yield increases.
Short term rates are set, primarily, by the U.S. Federal reserve (i.e. Greenspan) whereas
long term rates are set by market sentiment.
Economists (and others!) are interested in the difference between long term (usually 30-year
Treasuries) and short term (3-month T bills) rates.
If the long term rate is (heaven forbid) less than the short term rate,
it's an indication of (perhaps) a coming recession - meaning two successive quarters with
negative GDP growth.
>Perhaps? What does that mean?
It has, in the past, been a reasonable indicator of a coming recession.
Okay, we'll look at the Fed Rate and 30-year Treasuries and see whether ...
>You said economists look at 3-month T bills, so why the Fed Rate?
Do I look like an economist?
Anyway, there's little difference between Fed Rates and 3-month T-bill rates and the predictive
prowess of the Yield Curve isn't so precise that ...
>A picture is worth a 1000%.
Okay, here's a picture:
>Did I tell you the one about the economist who ...?|
Here's a chart of the Fed Rate and the
30-year Treasuries, from 1977 to 2000
and the Difference between them.
There are periods in the early 1980s and early 1990s when this Difference
was (heaven forbid) negative!
The lower chart shows the quarter-to-quarter percentage change in U.S. Gross Domestic product
(as well as the magic Difference).
If we regard significant, prolonged decreases in the GDP as a sign of a recession, then it
would appear that the negative Difference did indeed
predict a recession.
>You're talking about the past and everybuddy knows that past performance
doesn't predict future ...
Yes, yes. Quite right ... but it's interesting, eh?
>Besides, I don't see any predictions in that chart ... Fig. 2, I mean.|
Let's look more closely at the chart for the early 1990s.
Here you can see that the inversion of the yield curve did predict the recession.
the inversion lasted as long as the subsequent recession.
Uh ... if the long term rate is smaller
than the short term, they say the Yield Curve is inverted.
>But... but ... according to Fig. 2 it's inverted right now ... April, 2001!
It is, isn't it ... but just to be sure, check out the
Current Yield Curve (compliments of money.cnn):