Barron’s notes that while Bernanke did not utter those four special words, the meaning of his speech this past Monday essentially said the same thing:
IT’S DIFFERENT THIS TIME. No four words have been more costly to investors, whether they referred to tulips or dot-coms. And the greater the intellect behind each new theory, the more likely it will come a cropper. After all, it takes a certain genius to make a case for Dow 36,000.
Ben Bernanke had his coming-out party last week, giving his first big speech as Fed chairman to the Economics Club of New York. And for that hip crowd, he chose an equally scintillating topic, the yield curve…
The yield curve is the current hot topic, especially since the puppeteers at the Fed have been yanking up the short end for going on two years while the long end has drooped. The curve, as aficionados refer to it, is pretty much a straight line around 4.65% to 4.70%. The new Fed head offered several explanations of why that might be: Inflation’s low and expected to stay that way, just as in the ‘Fifties and ‘Sixties; the level of "real," or inflation-adjusted, interest rates has moved down a notch, or there is a global glut of savings and not enough investment to mop it up.
Bernanke also suggested what the yield curve didn’t mean — that the economy was about to slow, or worse, head into recession. No matter that every economic contraction has been presaged by a flat or inverted yield curve (that is, higher short-term than long-term rates, the inverse of the usual shape). This time is different, the former Princeton professor argued, and apparently persuaded much of the crowd.
Not Northern Trust’s Paul Kasriel, however. He points out that back in those Happy Days of low and stable interest rates, the August 1957-April 1958 and April 1960-February 1961 recessions both were preceded by flat but not inverted yield curves. Real short rates were even negative going into the ’57 downturn, so the Fed wasn’t exactly turning the screws real tight.
A flat to inverted yield curve isn’t so much a cause as a symptom of what’s happening in the credit system. Investors are willing to lock up money for a decade or more without getting paid any extra only because they think short-term rates are going to fall in the future.
Other symptoms? Housing rolling over, high Oil prices, protectionist politicians, and my personal favorite, explanations for why its different this time . . .
Famous Last Words
RANDALL W. FORSYTH
Barron’s MONDAY, MARCH 27, 2006
Fact-Checking Bernanke’s Yield Curve Comments
Paul L. Kasriel
Northern Trust Global Economic Research, March 21, 2006