Topsy-turvy interest rates have some people worried, but economists interpret the current rate picture to mean that the record economic expansion is safe for a while.
With longer-term Treasury securities trading at lower yields than those of medium-term duration, the Treasury yield curve has inverted - often a bad sign for the economy. It means the cost of borrowing at a maturity of five years is higher than for 10 years, presumably reducing the profitability of bank loans , and that 10-year note yields are higher than those on the 30-year bond.
But these economists point out that the part of the Treasury yield curve most crucial to banks and other borrowers of capital is doing just fine. Because banks mainly depend on funding of short duration, they can continue to borrow money to fund loan growth as long as the overnight funds rate is lower than, say, the two-year note yield. That means the continuation of economic expansion because banks and other companies won't feel constraint on their spending, economists say.
"We are home free for another year," said David Littman, chief economist at Comerica Inc. of Detroit.
Using January economic data, Mr. Littman said the probability of a recession is 11%. To make a recession a sure thing, his index - which tracks the yield curve, money supply, and economic indicators - would have to exceed 50% for four consecutive months.
Yields on 10-year Treasury notes have been about 65 basis points higher than the fed funds rate recently. Though 30-year bonds have lower yields these days, that longer end of the curve is irrelevant to predicting the performance of the economy. Rather than reflecting a tightening of monetary policy, the inversion of that part of the curve is a result of the Treasury's effort to scale back the supply of 30-year bonds.
"The yield curve is inverted - it is just not the [relevant] part," said William Dudley, chief economist at Goldman Sachs Group Inc. "Don't expect a slowdown [based] on the shape of the yield curve."
In the past, flat or inverted portions of the curve up to 10 years maturity have reflected tight monetary policy, which is "associated with an economy that subsequently slows," Mr. Dudley said.
That may be the case down the road, if the Fed follows through with more interest rate hikes. Indeed, the trading of eurodollars at 7% indicates the market already expects the Fed to raise the federal funds rate by 75 basis points, Mr. Dudley said.
"The market is applyingthe thinking [that] the curve will invert or get very flat eventually," he said. "But the Fed has to ratify the market's expectations first."
The timing of any Fed action will mean a lot for bank stocks, said Mr. Littman of Comerica. Bank stocks tend to bottom out about six months before interest rates peak. For example, during the last sustained period of rising rates, five years ago, the overnight lending rate hit a peak of 6.05% in April 1995 before easing again. Bank stocks hit a bottom in November 1994 before starting an upward swing.