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Dec. 27 (Bloomberg) --
U.S. two-year Treasury yields rose above 10-year yields for the first time in about five years, producing a so-called inverted yield curve, after the Federal Reserve raised interest rates 13 straight times since June 2004.
Investors have pushed up short-term yields in response to the Fed rate increases, while driving down long-term yields on speculation the central bank's actions will keep inflation tame. Inflation erodes the purchasing power of fixed-income payments.
"The economic data has remained strong enough for people to expect the Fed to continue tightening," said Graig Fantuzzi, a debt strategist at Morgan Stanley in New York. At the same time, "enough people are worried about home prices and the consumer to keep long-end yields down."
An inverted curve, where short-term yields exceed long-term yields, last happened in December 2000 and has preceded each of the past four U.S. recessions.
The debate among investors and economists now is whether another slowdown is looming, especially with high energy prices threatening to damp consumer spending.
Two-year notes yielded 4.34 percent at 4:10 p.m. in New York, above the 4.33 percent for 10-year yields, according to Cantor Fitzgerald LP. Longer-term debt typically yields more than shorter-term debt to compensate investors for risks such as the potential for faster inflation. The yields ended little changed from each other at 4.34 percent.
Ten-year notes' yield advantage shrank from 2.82 percentage points on June 29, 2004, the day before the Fed starting lifting its interest-rate target for overnight loans between banks. Over that time, the two-year note's yield has risen from 2.81 percent, while the 10-year note's yield has fallen from 4.69 percent.
Curve History
Over the past 20 years, 10-year yields exceeded two-year yields by 93 basis points, or 0.93 percentage point, on average.
Since 1980, the Treasury market has gone through six "distinct" periods of yield-curve inversions, according to New York-based Cantor, one of the two largest bond brokers.
The inversions averaged -45.9 basis points, with a minimum of -8.7 basis points and a maximum of -133 basis points, according to Cantor.
Each inversion lasted 30.5 weeks on average, with the shortest episode lasting nine weeks, and the longest lasting 59 weeks. In 2000, the curve was inverted from February to December.
What was different in 2000 is that the economy was slowing. The Fed cut its interest-rate target 11 times in 2001, to 1.75 percent from 6.5 percent. This year, the economy grew at a 4.1 percent annual pace from July through September, the 10th straight quarter exceeding 3 percent. The stretch is the longest since the 13 quarters through the first three months of 1986.
"Ominous Sign"
Bear Stearns Cos. expects any inversion to last "several" months, according to David Boberski, head of interest rate strategy at the New York-based firm.
"It will stay inverted until it's clear we're at the peak of the business cycle and rate hikes are done," Boberski said Dec. 20. "Whether we're coming up to that peak in the next few quarters is unclear."
An inversion would still likely be viewed as an "ominous sign" for the economy and be followed by an economic slowdown, or even a recession, said Tony Crescenzi, a bond strategist at Miller, Tabak & Co. in New York. He wrote a book called "The Strategic Bond Investor."
"What it suggests this time is a 2 percent economy in 2006, as opposed to a recession," said Bill Gross, chief investment officer at Newport Beach California-based Pacific Investment Management Co. and manager of the world's biggest bond fund.
Consumer Prices
Fed Chairman Alan Greenspan said in congressional testimony in July that there is "a misconception" of the importance of the yield curve. The curve's "efficacy as a forecasting tool has diminished very dramatically."
Some investors and analysts have suggested the Fed's ability to tame inflation has helped keep long-term yields low.
Prices for personal consumption expenditures excluding food and energy rose 0.1 percent in November, the same as October. From a year ago, the index increased 1.8 percent, down from 1.9 percent in October, a government report showed. The Fed uses the PCE index in making its semi-annual forecasts. In July, the central bank said it expected the core rate to rise by between 1.75 percent and 2 percent this year.
"The flattening of the yield curve shows the Fed clearly has inflation under control," said David Glocke, who manages about $9 billion in Treasuries at mutual fund firm Vanguard Group Inc. in Valley Forge, Pennsylvania. "People need to take into account the strength of the U.S. economy. I don't think the flattening of the yield curve is really indicative of any threat to the economy down the road."
No "Pain"
The central bank, after raising rates on Dec. 13, stopped saying there is "accommodation" in its policy, a sign members consider rates high enough that they're no longer spurring economic growth.
"Some further measured policy firming is likely to be needed" to ensure the economy keeps growing without stoking inflation, the Fed said in its statement. "Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained."
Since May 2004, Fed statements announcing its decisions on rates have said policy makers expect to raise rates at a "measured" pace.
"Where is the pain from the Fed hiking rates?" James Bianco, head of Bianco Research LLC in Chicago, wrote in a Dec. 12 research note. "As we see it, this rate-hike campaign has doled out a lot of pleasure and a little pain. So why should the Fed stop now?"
Home prices will jump 13 percent this year, the most since 1979, according to Fannie Mae, the largest source of money for U.S. home loans.
Merrill Forecast
Merrill Lynch & Co. debt strategists forecast the yield curve will steepen in 2006 as investors begin to anticipate an end to Fed rate increases.
Investors in longer-term debt will demand higher yields to compensate for the risk inflation will accelerate, even though the Fed says those risks are contained, Joseph Shatz, a government bond strategist at New York-based Merrill Lynch, said last week.
Ten-year notes yield about 85 basis points more than the rate of inflation, as measured by the annual rate of increase in consumer prices. The average over the past 20 years is 3.35 percentage points.
Investors benefit as higher short-term yields increase rates on savings accounts and money market funds.
The seven-day average yield of taxable money market funds ended Dec. 20 at 3.63 percent, the highest since June 2001, according the Money Fund Report, an industry newsletter. Money fund assets have risen 5.7 percent this year to $15.7 billion, the first annual gain since 2001.
The following are the periods of yield curve inversion since 1980, according to Cantor Fitzgerald.
Start End
Jan. 1, 1980 April 25, 1980
Sep. 12, 1980 Oct. 23, 1980
Jan. 22, 1982 July 16, 1982
Jan. 6, 1989 June 23, 1989
Aug. 11, 1989 Oct. 6, 1989
Feb. 24, 2000 Dec. 22, 2000
* from June 12, 1998, to July 24, 1998, the yield curve inverted by an average 1.14 basis points as markets weighed the Fed's reaction to Russian debt crisis and LTCM, according to Cantor Fitzgerald.
To contact the reporter on this story:
Robert Burgess in New York at
bburgess@bloomberg.net.
Last Updated: December 27, 2005 17:18 EST
Enviado: 4/2/2006 22:14
