Officially Inverted and Front-Page News

As per the front-page of most/all of today’s financial publications, and as was alluded to in my 12/24/05 posting, the 2-year and 10-year Treasury Notes finally inverted (i.e., the yield on the 2-year notes is higher than the yield on the 10-year notes).  This is important because a material inversion (extent and duration) normally means a recession is on the horizon.  So will this be a material inversion?  Will we still be inverted when liquidity comes back to the bond market in January??  When Alan "Bubbles" Greenspan retires at the end of January???  If still inverted, how inverted????  And what the heck will the dollar be doing?!  As you know, I think now is a great time to diversify out of the dollar (before 2006 begins).  We’ll leave it at that for now.  Cheers!

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FROM TODAY’S IBD:
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Yield Curve Inverts, 1st Time In 5 Years, Ups Recession Talk
News Triggers Stock Slide
2-year yield over 10-year often presages slumps; Greenspan has doubts

BY LAURA MANDARO INVESTOR’S BUSINESS DAILY

The yield curve inverted Tuesday, as rates on two-year Treasuries eclipsed those on 10-year notes for the first time in five years.
   The two-year yield is now 4.35%, and the benchmark 10-year yield is 4.34%, the lowest close since September.
   That means bond buyers are willing to take a slightly lower rate for locking up their money for a decade than they are for two years.
   In past business cycles, inverted yield curves have frequently foreshadowed recessions.
   “The market’s saying we’re not quite at the peak of the business cycle, but traders expect the peak to come in the first half of 2006,” said David Boberski, head of interest rate strategy at Bear Stearns.
   The two-year and 10-year yield curve last turned inverted in February 2000 and stayed that way for 10 months. Just over a year after first inverting, the economy slipped into recession.
   Similarly, 18 months after the two-year/10-year yield spread turned negative in 1989, economic growth turned negative.
   Fears of a repeat of these cycles weighed on stocks. The S&P 500, Nasdaq and Dow fell 1%. The small-cap S&P 600 sank 1.5%.
   The yield curve has steadily flattened for the past year. The Federal Reserve has jacked up shortterm rates, but long-term rates haven’t moved much at all.
   The federal funds rate stands at 4.25%, up from 1% in June 2004. Bond traders expect at least one more rate hike as the Fed tries to root out any inflation pressures.
   Meantime, heavy demand has kept long-term yields low. Bond investors just don’t seem worried about inflation.
   Some economists think this cycle could be different from 1990 and 2000. They cite 1992-94, when two-year/10-year spreads nearly turned negative. Instead of recession, that presaged an economic and stock market boom.
   The spread bottomed in December 1994 as the Fed neared the end of a tightening cycle to head off inflation pressures. Sound familiar?
   “The yield curve got very flat in the 1992-94 period, and we had the longest postwar expansion following that,” said A.G. Edwards’ chief fixed-income strategist Bill Hornbarger.
   These views echo those of Alan Greenspan. The outgoing Federal Reserve Chairman recently noted that a flattening of the yield curve “is not a foolproof indicator of future economic weakness.”
   But even the Fed’s own studies have found it bears watching.
   A New York Fed analysis of business cycles from 1960-95 found a 25% recession risk when the yield gap between three-month and 10-year Treasuries fell to 2 basis points. That yield spread narrowed to 37 basis points Tuesday.
   Other parts of the curve inverted. Yields on six-month Treasuries are at 4.32%, surpassing those on three- and five-year notes.
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