yield curve partially inverts

at the moment, the 5-year treasury offers a lower yield than the 2-year treasury.

http://money.cnn.com/markets/bondcenter/

Bonds
Nov 28 12:30pm ET † Price Change Yield Yld Chng

2 yr 99 27/32 +2/32 4.32 -0.03
5 yr 100 26/32 +6/32 4.31 -0.04
10 yr 100 26/32 +8/32 4.39 -0.03
30 yr 111 9/32 +26/32 4.61 -0.05

an inverted yield curve is a bad thing.

however, there are some reasons to think this time is different, namely, that foreign investors (the chinese government, in particular) have been buying long bonds like crazy, thereby "artificially" driving long rates low.

so, the argument goes, the yield curve is not where it is because of actual underlying economic conditions, but rather, because of peculiar market conditions.

on the other hand, there's ALWAYS a reason to think "this time is different", and yet, inverted yield curves still predict recessions.

beyond that, inverted yield curves have real consequences, most notably, for banks who like to borrow short and lend long. when they can't make a profit at this, this hurts them big time.

Can you explain the significance of that in layman's terms?

although at the moment we only have a partially inverted curve, and only barely, at that. a fully inverted curve would be when the long the bond, the lower the yield. today, this is the case when looking at the 2- and 5- year treasuries, but not when looking at the rest of the curve.

as a practical matter, this hurts the banking sector as much of their business involves borrowing at short rates and lending at long rates. when the long rates are lower than the short rates, there's no profit in it, so business suffers.

in this case, i would expect banks to lose their enthusiasm for car loans, although much car loan financing is complicated by virtue of the close ties auto lenders have with manufacturers (e.g., gmac).


in any event, this could lead to a capital crunch, which could in turn lead to a recession. although, with the current capital glut, this may take a while to have such a negative effect.

the long term stability of the economy as more vulnerable than the short term? That is, we may be going to hell in a hand basket, but we can hold on for a while yet! Is this too simple? Am I restating the obvious? I'm thinking the long term impact of boomer retirement, medicare, social security and the underfunding of pensions.

Historically when the curve inverts it has lead to a recession.

Bryant
Check it out --> http://politicalcomment.blogspot.com

time it's happened in America.

However, it has happened twice in Japan without a recession following.

The most famous inverted yield cutrve was in the late 70's, early 80's when you could get 18 % for a one year CD or 14 % for a 5 year CD.

That's not a good sign.

We are in a great economy, everything is fine!

...watching short-term interest rates spike on bankrate with little corresponding motion in longer term rates. I knew we were near the ceiling already and that's a bad sign.

On the plus side, interest rates on some CDs are now above the interest rates on some student loans. So that helps a few people I know start saving a time-buffer for payments.

... and anyone with a passing interest in economics should Google "inverted yield curve" for some good (and not so good :)) explanations of what this is and what it means.

IMHO, it is just another of several small pieces of a puzzle that equals flagging economy.

are basically saying the chinese are acting irrationally.

that may be the case, but it is rarely a good bet to assume that a player with market power is acting irrationally.