Commercial PropertyWhat Does An Inverted Yield Curve Mean?
Are we teetering on the edge of a recession? One harbinger, the inverted yield curve, says yes.
On Tuesday, December 27th, the yield on 10-year Treasuries fell briefly below the yield on two-year notes several times, and at one point, 10-year yields had slipped to about 4.397 percent, while 2-year yields were at 4.411 percent.
The last time the yield curve inverted was in 2000, which economists say predicted the U.S. recession in 2001, a recession so slight that it wasn"t recognized until retroactive calculations revealed it in 2003.
An inverted yield curve is a rare, solar-eclipse type of event because investors expect higher yields on longer-term bonds, which compensates for higher risks of more cost and less return later. The yield curve refers to the term structure of interest rates. It is a graphical representation of rates for returns for short-term to long-term Treasuries and is used to determine the value of government-issued bonds and attendant interest rates. When long-term yields are below that of short-term yields, the curve is said to be inverted.
Since banks and securities firms borrow at short-term rates and lend out their money at long-term rates, an inverted yield curve is a good reason to stop lending money. Interest rates on the shortest-term bonds correlate very closely with the interest rates set by the Federal Reserve Board, currently at about 4.4 percent. Long-term interest rates, because of the length of the term are influenced by many factors including investor optimism or pessimism about inflation and economic growth.
Mortgage interest rates may trend but aren"t tied to 10-year Treasury debt prices.
"Fixed rates are directly tied to their respective mortgage bond," explains David Reed, author of Mortgages 101, Amacon. "Lenders price their fixed products on these bonds, not the 10-year."
When the yield falls on 10-year Treasuries, mortgage interest rates tend to follow, which could be continuing good news for homebuyers. The bad news is that it could be the first signal of an economic slowdown, which may cause the Federal Reserve to pause in raising short-term interest rates, after 13 rate increases over an 18-month period.
Some say the inverted yield curve has lost its crystal ball ability to forecast an economic slowdown because of so much foreign participation in U.S. bond markets. Fed chief Alan Greenspan told the federal banking committee that in July, 2005.
Yet others say the yield curve has accurately predicted economic slowdowns since 1960.
Real estate investors cited by BetterInvesting"s most recent Harris Interactive poll says that real estate was the top investment choice of 16 percent of its shareholders, down from 22 percent in 2004, keeping it in the top three investment strategies along with energy and pharmaceuticals. More than half of respondent shareholders said real estate is a good investment, with 79 percent saying that it is as good or better an investment than a year ago. Thirty-six percent believe it will be worse.