Monday, August 16, 2010

The Importance of the Yield Curve

Historically, the yield curve has been a strong predictor of where the U.S. economy is headed. Essentially, the yield curve is the difference between long-term (10-year treasury notes) and short-term (two-year treasury notes) U.S. government debt yields. Basically, if long-term debt is offering significantly higher returns than short-term debt, investors are expecting the economy to expand. Conversely, nearly every time the yield on short-term debt has surpassed the yield on long-term debt - known as an inverted yield curve - a recession has followed.

Back in February, the difference in yields on the 10-year and two-year treasury notes hit 2.929 percentage points, which was a record high. The yield curve is now at 2.16 percentage points, which is still quite high by historical standards. This is a key reason why many economists see little chance of a double dip recession.

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