Tags: Cleveland Fed Bond Data Show Rising Recession Risk

Cleveland Fed: Bond Data Show Rising Recession Risk

Friday, 24 Sep 2010 10:15 AM

The narrowing premium Treasury investors demand to hold longer-term government debt signals a rising chance the economy will slip into another recession, according to the Federal Reserve Bank of Cleveland.

The probability the economy will begin contracting was 18.5 percent in August, compared with 12.4 percent in June, Joseph G. Haubrich, head of banking and financial institutions research at the Cleveland Fed, and Timothy Bianco, a researcher, wrote in a report published Thursday. They cited a drop in the difference between 10-year note yields and 3-month bill rates to 2.45 percentage points in August from 3.17 percentage points in June.

“Generally, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth,” Haubrich and Bianco wrote.

While economic reports have sparked concern that the U.S. economy will contract for the second time in three years, the flattened yield curve still indicates a four-in-five probability that the economy will grow further, advancing at a 1 percent annual pace, the economists wrote.

Economic growth slowed to a 1.6 percent annual pace in the second quarter, from 3.7 percent from January through March, the Commerce Department reported Aug. 27.

The difference between 2- and 10-year yields shrank to 1.96 percentage points on Aug. 26, the lowest level since April 2009, from a record high of 2.94 percentage points on Feb. 18. The yield curve steepened after the Fed raised its discount rate for the first time since 2006.

‘Flattening Potential’

Yields on two-year notes are “struggling around 40 basis points, and the bond is still well away from yield levels that were traded even in the middle of last month,” said William O’Donnell, U.S. government bond strategist in Stamford, Connecticut, at Royal Bank of Scotland PLC. “The upside potential is for the back end, and therefore the flattening potential for the curve is pretty good.”

The 10-year note yield was little changed at 2.55 percent today after touching 2.48 percent, the lowest level since Sept. 1. The bill rate was 0.15 percent, while the spread was 2.40 percentage points. The two-year note yield was 0.42 percent, compared with the record low of 0.41 percent reached yesterday.

Treasury 10-year notes rallied on Sept. 21, when the Federal Reserve said following its policy meeting that it’s willing to ease monetary policy further to boost the economy.

‘Matter of Time’

“It’s only a matter of time before 10-year notes trade at 2 percent,” said Ray Remy, head of fixed income in New York at Daiwa Securities Group Inc., one of the 18 primary dealers that trade directly with the central bank. “If they’re purchasing, they have an unlimited checkbook. They have a mission in mind, and that’s to move longer rates lower.”

An inverted yield curve, reflecting shorter-term rates higher than longer-term rates, usually indicates a recession is coming, the Cleveland Fed economists wrote.

The curve inverted, with 2-year yields topping 10-year yields, before each of the last seven recessions, according to Haubrich and Bianco. They cited two “false positives” in late 1966 and late 1998.

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The narrowing premium Treasury investors demand to hold longer-term government debt signals a rising chance the economy will slip into another recession, according to the Federal Reserve Bank of Cleveland.The probability the economy will begin contracting was 18.5 percent...
Cleveland Fed Bond Data Show Rising Recession Risk
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2010-15-24
 

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