US govt bonds - Yield curve inverts for first time in five years

[Paciente]

27 Dec 2005 15:28 GMT


US govt bonds - Yield curve inverts for first time in five years


NEW YORK (AFX) - Treasurys were lower in early trade Tuesday after the spread between the 2-year note and the 10-year note briefly inverted for the first time in five years.

An inverted yield curve occurs when short-term maturities pay a higher interest rate than longer-term maturities.

Such an event has typically foreshadowed a noticeable downturn in the economy and, usually, a recession. With an inverted yield curve, banks can no longer make money by borrowing short-term money and lending it at longer terms.

The inversion came in European trade when the 2-year note yielded 4.411% versus a 10-year yield of 4.405%.

In early New York trade, the yield curve normalized with the 2-year yielding 4.381%, while the 10-year yield stood at 4.384%. Still, a large part of the yield curve was still inverted, with 5-year notes yielding just 4.338%.

"The market has been pressing for curve inversion for several weeks," said economists at Action Economics, who said they expected it would be a temporary development.

The last time the yield curve inverted was in 2000, before the last U.S. recession and a period of aggressive rate cuts by the Federal Reserve.

Some economists continue to eye the yield curve as a critical economic indicator. Others say it's lost its usefulness because special factors, such as the government shifting issuance to shorter maturities, have distorted the curve's economic signals.

The Fed too has played down the bearish implications of inversion, although "many in the market are much less prone to shrug it off," said Action Economics.

Still, "the backdrop of robust growth and benign inflation suggests that the market is not signaling a slowdown in growth which has been the case in prior curve inversions," Action said.

With no economic data on tap Tuesday, the market is now looking to the Treasury's announcement of 2-year notes and 4-week bills later in the session.

The Treasury is expected to announce an auction of $20 billion in 2-year notes. The extra supply is expected to keep pressure on the 2-year note.

Elsewhere across the yield curve, the 5-year note was yielding 4.345% and the 30-year was yielding 4.56%.