John Mauldin Urges Caution

" Let's start with a review of the yield curve. Basically, it is the difference between short term and long term rates. When short term rates rise above long term rates, the curve is said to go "negative" or "inverted." This is important, because as Professor Campbell Harvey (at the Fuqua School of Business at Duke) first pointed out in his doctoral dissertation at the University of Chicago, the yield curve is the best predictor of an impending recession....

Typically, when the yield curve goes negative for about 90 days or more, the country goes into recession within 12 months. Thus, with the yield curve getting flatter and flatter, people like me start to pay closer attention. Because, while it should seem obvious, a necessary pre-condition for a negative or inverted yield curve is a flattening yield curve.

The difference between the two year and the ten year is today only 21 basis point. The ten year is at 4.24% as I write. But we normally measure the yield curve from the 90 day, which is basically the Fed fund rate, which is now 3.5%. For the yield curve to go negative either long rates would have to drop or short term rates would have to rise, or a combination of both. "

Timothy Burger
timothyb(at)timothyburger.com