Transcript SBA-BIG

Updated April 13, 2006
Yield Curve Inversions and
Future Economic Growth
Campbell R. Harvey
Duke University, Durham, NC USA
National Bureau of Economic Research, Cambridge MA USA
[email protected]
+1 919.660.7768 office || +1 919.271.8156 mobile
http://www.duke.edu/~charvey
1
Issue
• Certain parts of the yield curve have inverted which means
short-term rates are higher than long-term rates
• Yield curve inversions were the topic of my 1986
dissertation at the University of Chicago
• I developed a model based on work by Breeden (1979) that
linked inversions to future economic recessions
• Are we headed towards a recession?
2
Historical Track Record
• The measure attracted significant attention in accurately
forecasting the recession of July 1990-March 1991.
• The measure also avoided false signals (for example, it
forecasted strong growth in 1988 after the October 1987
crash and it forecasted strong growth in 1999 after the
August 1998 financial crisis).
3
Evaluation of the Last Recession
• In July 2000, the Yield Curve inverted forecasting
recession to begin in June 2001.
• Official NBER Peak is March 2001 (Yield Curve within
one quarter accurate).
• In March 2001, the Yield Curve returned to normal
forecasting the end of the recession in November 2001.
• On July 17, 2003 the NBER announced the official end of
the recession was November 2001.
4
Exhibit 1
Lead Lag Analysis in Months
Business Cycle
5-Year Yield Spread
NBER NBER
Length
Length of
Peak
Trough
of Cycle Inversion Lead Normal Lead
Inversion
Dec-69
Nov-70
11
Oct-68
14
Feb-70
9
16
Nov-73
Mar-75
16
Jun-73
5
Jan-75
2
19
Jan-80
Jul-80
6
Nov-78
14 May-80
2
18
Jul-81
Nov-82
16
Oct-80
9
Oct-81
13
12
Jul-90
Mar-91
8
May-89
14
Feb-90
13
9
Average last four
11
11
7
15
Recent Recession
Mar-01
Nov-01
8
Jul-00
8
Mar-01
8
8
5
Exhibit 2
Forecast evaluation
Term
Structure
Inversion
Date
Jul-2000
Average
Forecast
Actual
Lead to
Beginning Recession
Recession of Recession Begins
11
Term
Structure
Average
Normal Date Lead
Mar-2001
8
Jun-2001 Mar-2001
Forecast
End of
Recession
Error
3
Actual End Error
Nov-2001 Nov-2001
0
6
Yield Curve Inverts Before Last Six Recessions
(5-year Treasury note minus 3-month Treasury bill yield-secondary)
Annual
GDP growth
or Yield Curve %
% Real annual GDP growth
8
6
4
2
0
Recession
Correct
Recent
flattening
Yield curve accurate
in recent recession
Data though April 11, 2006
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
-2
Recession
Correct Recession
-4
Correct 2 Recessions
Correct
-6
Yield curve
7
Source: Campbell R. Harvey. Update of Harvey (1986, 1988, 1989).
Yield Curve Inverts Before Last Six Recessions
(5-year Treasury note minus 3-month Treasury bill yield – constant maturity)
Annual
GDP growth
or Yield Curve %
% Real annual GDP growth
8
6
4
2
0
Recession
Correct
Recent
flattening
Yield curve accurate
in recent recession
Data though April 11, 2006
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
-2
Recession
Correct Recession
-4
Correct 2 Recessions
Correct
-6
Yield curve
8
Source: Campbell R. Harvey. Update of Harvey (1986, 1988, 1989).
Recent Annualized One-Quarter GDP Growth
(10-year and 5-year Yield Curves-secondary market)
Annualized
1-quarter
GDP growth
8
10-year
Yield curve
4
% Real annualized one-quarter GDP growth
6
3
4
2
2
1
0
0
-2
5-year
Both curves
invert 2000Q3
-1
Data though April 11, 2006
-2
M
ar
-9
Se 5
p9
M 5
ar
-9
Se 6
p9
M 6
ar
-9
Se 7
p9
M 7
ar
-9
Se 8
p9
M 8
ar
-9
Se 9
p9
M 9
ar
-0
Se 0
p0
M 0
ar
-0
Se 1
p0
M 1
ar
-0
Se 2
p0
M 2
ar
-0
Se 3
p0
M 3
ar
-0
Se 4
p0
M 4
ar
-0
Se 5
p0
M 5
ar
-0
6
-4
9
Recent Annualized One-Quarter GDP Growth
(10-year and 5-year Yield Curves-constant maturity)
Annualized
1-quarter
GDP growth
8
10-year
Yield curve
4
% Real annualized one-quarter GDP growth
6
3
4
2
2
1
0
0
-2
5-year
Both curves
invert 2000Q3
-1
Data though April 2006
-2
M
ar
-9
Se 5
p9
M 5
ar
-9
Se 6
p9
M 6
ar
-9
Se 7
p9
M 7
ar
-9
Se 8
p9
M 8
ar
-9
Se 9
p9
M 9
ar
-0
Se 0
p0
M 0
ar
-0
Se 1
p0
M 1
ar
-0
Se 2
p0
M 2
ar
-0
Se 3
p0
M 3
ar
-0
Se 4
p0
M 4
ar
-0
Se 5
p0
M 5
ar
-0
6
-4
10
Current Situation
• 15 consecutive Federal Funds Rate increases yet the longterm bond rate has remained relatively flat.
• Why?
11
Current Situation
• In the past, the Federal Reserve Bank had some control
over long-term as well as short-term interest rates. Longterm rates could be impacted with its open market
operations.
• Given the dramatic increase in the size of the debt market,
control is now limited to the Fed Funds rate.
• The behavior of the long-term rate is a “conundrum” as
Former Chairman Greenspan remarked. Obviously, in the
recent Fed tightening, they were planning on the long-term
rate to increase. Long-term rates did not increase over 13
hikes.
12
Current Situation
1.
Fed Playing Catch Up With Short Rates. For an extended
period of time, the Fed Funds rate was negative (on an
inflation adjusted basis). This means that borrowing was
subsidized by the government. At least 10 of the Fed rate
hikes had no impact, because they were playing “catch
up”. That is, they were moving the rate to where it
should have been. This is why the last two hikes have
had “bite”. Long rates moved up as soon as the Fed
hiked.
13
Current Situation
2. Weaker economic growth. Consistent with my yield curve
model, the lower long-term rate signals lower expected
growth. The lower growth is consistent with the ISM index
hovering just above 50. There are growing signs of a
housing slowdown with Mortgage Applications running
below 2004 levels; new home sales down, housing prices
down, and homeowners with ARMs facing much higher
interest rates.
14
Current Situation
3. Inflation perceptions. The long-term rate is a combination
of expected inflation, expected real interest rates and an
inflation risk factor. Long-term inflation expectations have
decreased mainly due to the glut of cheap labor resulting
from globalization.
15
Current Situation
4. Strong buying of long-term bonds by foreigners. For the
past few years, strong buying by Asian central banks have
pushed up the Treasury bond prices. However, there is a
debate as to whether this has had a large impact on bond
prices. In addition, this buying has flattened out recently. A
recent Fed study estimated that the foreign buying pushed
yields down by 150bp.
16
Current Situation
5. Hedge funds. There has been a recent increase in demand
for U.S. bonds from the Caribbean area indicating hedge
fund activity. With long-rates above short rates, many
managers do “carry trades” (borrow short-term and buy
long-term bonds hoping the relation between rates remains
stable). As the term structure flattens, many of these
managers increase their leverage which means more
buying pressure on the long-term bonds.
17
Current Situation
6. Demographic forces. As the population ages, more money
is allocated into fixed income and long-term bond yields
may decrease.
7. Inflation risk. The long-rate rates contain expected
inflation, expected real rates and an inflation risk factor. It
is widely perceived that inflation risk (an unexpected
episode of inflation turbulence) has decreased.
18
April 2006
• All three measures of core inflation (PPI, CPI, and PCE)
key things that new Fed chair will follow.
• Evidence of housing cooling. Question of whether it will
be a soft landing or a hard landing in the housing market.
• I fail to see a logic for a 16th hike in Fed Funds. Indeed, I
did not see the logic for the 15th. It will take a while for
these hikes to ‘work their way through the system’. Hence,
you need to stop earlier or you run the risk of overshooting
and destabilizing the economy.
19
April 2006
• Inverting the yield curve (even if it is a false signal) will
likely increase disagreement among market participants
because most associate inversions with bad economic news
• Increased disagreement will lead to higher VIX and
corporate spreads
• Increased vol leads to higher costs of capital
• Higher costs of capital lead to less investment,
employment and ultimately a moderation in economic
growth
20
Recession?
• No inversion yet in key yield spreads calculated from
constant maturity basis
• With one more Fed hike, we could see an inversion
• If inversion occurs, model would forecast recession
beginning in Q3 2007.
21
Yield Curve and GDP Research Chronology
• Campbell R. Harvey’s Ph.D. Thesis, University of
Chicago, 1986.
• Campbell R. Harvey, “The Real Term Structure and
Consumption Growth,” Journal of Financial Economics,
1988
• Seven other works found at:
http://www.duke.edu/~charvey/research_term_structure.htm
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