Since 1953, the Treasury yield curve has been inverted - that is, the interest rate on a 3-year note was above that of a 10-year bond - about one-quarter of the time.

Consequently, yield curve inversions, though not considered normal, are far from being rare events.

Depending on how you count, there were seven to 10 periods of inversion since 1953. If the count of 10 is accepted, the range of duration was from seven to 20 months, and the average was 15.

Interest rates, short and long, do not stop rising when one of these inversions first occurs.

Excluding the 1979 to 1981 episodes (when oil price shocks sent consumer price inflation over 10%), the three-year Treasury rate rose by 9 to 208 basis points - the average was 96 - from the start of the inversion until the "peak" in rates.

The comparable figures for the 10-year Treasury rate were 0 to 177 basis points, with a 71-basis-point average.

The period between the initial inversion and the subsequent "peak" in interest rates ranged from one to 19 months, with a 10-month average.

Except in the late 1960s, inverted yield curves correctly signaled that an economic downturn was on the way. (During 1965 to 1967, the inversions correctly indicated that a slowdown in economic growth was at hand.) The initial yield curve inversion preceded the start of a recession by a range of nine to 19 months, with an average lead time of 14 months.

By our definition - three-year maturity versus 10-year - the yield curve came very close to being inverted as 1994 ended. In early January, the 3- year T-note rate and the 10-year T-bond rate were close to 7.80% and 7.86%, respectively.

We expect these two interest rates to invert by the end of this quarter.

Yield-curve history suggests that these early January levels will not be the peak in those interest rates. Further rises lie in store during the first half of 1995.

At their two-day meeting that starts today, Fed policymakers will raise the funds and discount rates by 50 basis points each, and a 75-basis point hike cannot be ruled out.

Fed officials will likely raise those two rates another 50 basis points in the spring. At that point, monetary policy will be deeper into restrictive territory, and Fed officials may be content to wait a good while longer to determine the consequences before raising rates again.

We expect monetary policy as reflected in a persistent yield-curve inversion to remain tight throughout much of 1995. If this expectation is correct, experience points to a high probability of a significant slowdown in economic growth starting in the latter half of 1995, and to a reasonable chance of a business downturn in 1996.

At that time, interest rates will decline, and the yield curve will return to its usual positive slope.

A big tax cut, however, in 1995 - unmatched by spending cuts - could postpone the start of a recession until after the 1996 presidential election.

This article originally appeared in PNC Bank's National Economic Outlook.

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