Crescenzi: Here is a Good Sign ... Maybe
Senior VP, Strategist, Portfolio Manager Pimco
The Treasury yield curve continues to steepen and is now at its steepest in close to four months. The steepening has both good and bad connotations to it.
(The yield curve shows the relationship between yields and maturity dates for Treasuries at a given point in time).
The most important positive is that a steep yield curve typically precedes economic recoveries. Today the spread between 3-month T-bills and 10-year T-notes—the key empirical gauge used in forecasting models—is 273 basis points, a level that historically has indicated the chances of recession 12 months hence are very small.
For example, in a study by Estrella and Mishkin, a yield spread of more than 121 basis points was associated with just a 5 percent chance of recession, which makes the current level comforting. For reference, note that the same study showed that a yield spread of -82 basis points (an inverted yield curve), produced 50 percent odds of a recession. The yield spread was as wide as -60 basis points in February 2007.
Some of the recent steepening of the yield curve reflects the increase in Treasury supply, with the long-end of the yield curve bearing the burden. This is the negative side of the steepening.
If the U.S. dollar were to fall, any steepening would take on an even larger negative connotation, but the dollar's decline would have to be significant to have meaningful impact on the yield curve.
The negative implication of a significant dollar drop and sharply steeper curve is the message it sends regarding the global appetite for U.S. assets. Any increase in the cost of capital in the U.S. would complicate efforts to battle the financial and economic crisis.
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."