Thursday, August 9, 2018

Is the Economy Really Different This Time?

A negative yield curve spread where short-term interest rates are higher than long rates has been a very good early indicator of a recession ahead.

Click on chart for larger view.
In the chart above, red dashed lines indicate the yield curve spread turning negative. The letter "R" indicates a recession.

The current yield curve spread (10-Year Treasury interest rate minus the 2-Year Treasury) is a positive 0.30. But the steady decline does not seem to worry the Fed. Fed members think "it is different this time."

The Keynesian Brad DeLong is correct on the point that it is not different this time:
The Fed today has a “habitat theory” about why this time is different – that is, why the preferences of investors for particular maturity lengths imply that a yield-curve inversion would not mean what it has always meant. But 2006, just before the financial crisis hit, was supposed to be different, too. (And there were plenty of times before then that were supposed to be different, too.) History suggests that this time is highly unlikely to be different – and that it will not end well if the Fed continues to believe and behave otherwise.
He wants more Fed printing to keep the yield curve spread positive. That is, he wants the Fed to stay in the interest rate manipulation game when the Fed should really close its open market operation desk but he is correct that Fed operations that invert the yield curve will not produce a result different from the past and that a recession is very likely to follow a negative yield curve spread.

-RW 

Also see: A Major Economic Indicator Looks Like It May Start Flashing Danger Soon