Tuesday, August 23, 2011

Recession: Yield Curve (Explained) Shows Potential Rough Times Ahead In The Economy

I want to repeat this again:  while Wall Street seemed to have recovered since 2008, those of us on Main Street, USA is still in a recession.  So, recession is in or out, over with or coming again is all relative.  Having said that, the yield curve, an indicator used by traders and economists, seems to suggest that rougher waters ahead for our economy.

Possibly a recession.

First, what is an yield curve (Wiki)?

  • It's a graph of interest rates (y axis) versus time (x axis).
  • Y-Axis - it's interest rates from zero and up
  • X-Axix - it's the time it takes for the US bond to mature.
  • Longer the time, typically, we see higher interest rates because buyers would not see their money back until later, hence, higher risk.
I think I've got the basics of that.

Now, the problem now, according to CNN,  is that the yield curve is showing that the interest rate difference between two-year bonds and the 10-year bonds have narrowed.  The numbers doesn't matter.  What it does mean is that people are buying bonds to park their money because they don't want to invest it in other securities because they see greater economic uncertainty and higher risks out there.

And what's correlating the fears of another recession is a manufacturing index, called Institute of Supply Management's manufacturing index.  Anything above 50 shows growth but its recently fell to less than 51.  

Europe is definite to blame.  Also the recent bone-headed Congressional move to risk US debt default also made things worse (walking away from a $4 trillion debt deal to end up with $2.5 trillion - talk about idiotic). 

Anyway, I thought these are some good information to know.

Back to the yield curve.  If you take at the CNN chart, it's a curve that goes up.  It's also possible to have an inverted yield curve where the longer term bonds has a lower interest rate than the shorter term ones.  What does it mean?  

It means things are gonna get really really bad.   

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