There have been several articles recently discussing the shape of the yield curve. In today's Wall Street Journal Online, Agnes T. Crane wrote Yield Curve Could Give Fed Pause (subscription required).
For many in the bond market, the signal from the shifting shape of the Treasury yield curve couldn't be clearer: The economy will slow, and the Federal Reserve will stop raising interest rates sooner than previously thought.
Whether the message is right is debatable. But investors are having a harder time ignoring the potential economic downside of $70-a-barrel oil prices and destruction wrought by Hurricane Katrina. A more than 14-point drop in the August Chicago purchasing-managers index, which measures area manufacturing activity, didn't help alleviate concerns.
Tuesday, yields of two- and three-year Treasury notes essentially changed places periodically, in which the longer of the maturities yielded less than the two-year note.
Yet the benchmark yield curve, which measures the distance between the two- and 10-year note, has moved further away in the past two trading sessions from such an inversion. The benchmark 10-year currently yields 0.19 percentage point more than its shorter-term counterpart. Monday, it yielded only 0.11 percentage point more.
As I have stated several times in my weblog, I am cautious in my outlook. High energy prices and Katrina will damp the economy. Sure some specific sectors will benefit because of Katrina, but the economy as a whole will not—just as the oil sector benefits because of high energy prices but the economy as a whole does not. The yield curve also appears to be indicating caution. Thus, I am inclined to think that the Fed will not continue to raise rates as previously thought.
If the Fed does stop its planned increases, will stock markets rebound on the lower than expected rates?
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