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Yield Curve: Signs of Big Economic Slowdown? (CNN article)

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Yield Curve: Signs of Big Economic Slowdown? (CNN article)

Unread postby LadyRuby » Thu 14 Jul 2005, 09:23:59

I'll admit I don't really understand this yield curve business. Any economists out there care to give me a "yield curve for dummies" lesson? Does this mean it's bad to invest in bonds? Where would the best investments be for this scenario?

Old conundrum, new twist

Inverted or flat, the yield curve points to a weaker Federal Reserve, not a downturn.
July 14, 2005: 7:10 AM EDT
By Katie Benner, CNN/Money staff writer

NEW YORK (CNN/Money) - When bond yields compete with Martha Stewart and Bernie Ebbers for headlines, they usually lose. But recently they've gotten attention by behaving in a way that has sparked fears of a big economic slowdown.

the article continues....
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Unread postby khebab » Thu 14 Jul 2005, 09:53:21

(Confused about yield curves? Click here for help.)

inside this page: CNN Money
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Re: Yield Curve: Signs of Big Economic Slowdown? (CNN articl

Unread postby stu » Thu 14 Jul 2005, 11:17:46

LadyRuby wrote:I'll admit I don't really understand this yield curve business. Any economists out there care to give me a "yield curve for dummies" lesson?

Me too. I read the guide to yield curves and I think I might have it figured out.

A yield curve is a prediction of how much return can be expected from payments that accrue interest.

A yield curve normally rises because in the long term interest rates are set to rise steadily so therefore there will be a steady yield.

When the curve flattens or inverts then it means that you are moving closer to a situation where interest rates will be high in the short term but low in the long term. This means that high interest rates will curtail consumer spending and the housing market (both forms of credit which involve repayment through interest rates obviously :roll: ).

The outcome will be a massive reduction in the demand for credit which can only be alleviated by lowering interest rates in the long term to try and entice consumer spending and other economic activities that rely on low interest rates to prosper.

I'm a beginner at economics too but I think thats the gist of it. Though it's bound to be more complex than that.
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Unread postby aahala » Thu 14 Jul 2005, 11:48:19

Inverted yield curves predict resessions about 7 out of 5 times.:D That is,
sometimes it doesn't happen.

Chapter #1:

Investors will demand returns relative to risk. It's riskier to predict the
future out 20 years than 1 so the "norm" will be a rising yield curve.
Lower rates for shorter terms, higher yields for longer term.

Chapter #2:

Investors will move to the best rate if the risk is the same and will
definately move to a better rate if the risk is less. Therefore the inverted
curve can't last long.

Chapter #3:

By moving to the shorter term, less money is available for long term
investments, driving up interest rates for the longer term and therefore
driving up costs of plant and equipment, mortgages etc, resulting in less
economic activity.

Warning: One should be very concerned making long term, fixed rate
investments during a rate inversion. The market value of such nvestments
always adjust to the present market conditions, higher rates in the future
could dramatically reduce the market value of long term bonds you bought
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Unread postby shakespear1 » Thu 14 Jul 2005, 11:50:16

You may find this link interesting to try to see what they are talking about

Dispelling The Certainty Myths About
Yield Curve Inversion As A Recession Indicator
by Bob Bronson
Bronson Capital Markets Research
June 30, 2005

Yield Curve
Men argue, nature acts !

"...In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

Alan Greenspan
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Unread postby nero » Thu 14 Jul 2005, 12:31:14

There are a couple of ways to look at the yield curve. Here's one:

The bond yield is* (See Note) the average of the anticipated overnight yields until the expiry of the bond. Therefore when the long dated bond has a higher interest rate than the short term bond it indicates that the market believes the overnight rate is going to increase in the future. Since the overnight rate is controlled by the Fed they would only increase it if they felt the economy was getting too hot and needed cooling off.

Conversely if the long dated bond yield was lower than the short term bond it indicates that the markets anticipate the overnight rate going lower. The Fed would only lower the rate if there was significant weakness in the economy therefore the yield indicates the market believes the economy will weaken.

* Note: This is a simplification. The bond yield should be the average of the anticipated overnight yields until the expiry of the bond. Historically, however, the long term rates are almost always higher than the short term rates, indicating that the market does not have an unbiased view of the future. People are more afraid of losing money than they are anxious to make money and will inherently demand a "risk" premium for holding long term bonds over short term bonds. Therefore to account for this bias economists believe that a flat yield curve is also an indication the market believes the economy will weaken.
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Unread postby RdSnt » Thu 14 Jul 2005, 16:25:55

I think you will see a direct relationship between low long-term yield rates and the proliferation of Income Trusts.
I regard income trusts as the endgame of corporate well extraction. Over the past 2 plus decades we've seen and huge consolidation of corporations, companies buying each other.
These were described as competitive necessities and a drive for economies of scale. Meaning that lots of people got fired.
What this buying spree really has been is managers maximizing the profitability of the company by canniblizing the assets.
Now that there are no victims left to put in pot they are eating themselves. Income Trusts.

What this means is that managers have given up on a future outlook and see no point in investing in the future. Extract the highest value in the short-term.
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