Inverted Treasury Yield Curve Signals Less Liquidity

At 4.40%, current yields on 10 Year Treasury securities for the most part match the yields on the 2 Year. Fed Chairman Alan Greenspan, and many economists, have indicated that the yield curve's ability to signal changes in economic conditions has slackened as financial markets have broadened and become more complex.

Narrow Money, Broad Money, and the Transmission of Monetary Policy from the Federal Reserve Bank of Richmond is available here.

In the past the move of toward parity, let alone inversion, of the 10-2 Year spread has preceded recessions in the U.S. Without fail it has signaled a marked slowing of liquidity and recently the growth in the monetary base has slowed to 3% from 9% in 2002.

The slowing reflects the effects of higher interest rates on consumers' inclination to borrow and spend as well as banks' inclination to lend.

Certainly, the U.S. economy is "awash in cash." But in a twelve trillion dollar economy such as the U.S., growth is determined at the margin.

The Economic Sentiment Indicator of Slovakia has been on a generally rising trend since early 2004. (See the first chart.) The index rose 0.4% in December to 113.4 (2000=100) from November and was 7.0% above the December, 2004 level of 106.0. The index is based on four confidence indicators that measure the balance between optimists and pessimists. These are the Industrial Confidence Indicator which has a weight of 40% and the Construction Confidence, the Consumer Confidence and the Retail Trade Confidence indicators each of which has a weight of 20%. A strong rise in confidence in the retail trade sector overcame weakness in confidence in the Industrial, Construction and Consumer sectors.

Consumers have generally taken a dim view of the economy. In December there were 17.8% more pessimists than optimists among consumers, an increase of 3.2 percentage points from November and 1.0 percentage points from December, 2004. Until the recent deterioration in consumer confidence, it had shown an improving trend starting in early 2004. In spite of the generally pessimistic view of consumers, retailers have consistently been, on balance, optimistic. In December the balance of optimists for retail trade was 23.0%, up from 22.0% in November and from a -6.7 in December of 2004. The contrast between the trends in consumer confidence and that of the retailers is shown in the second chart.

Similar trends are found in comparing confidence in the Industrial and Constructions sectors, as shown in the third chart. Except for a small excess of pessimists in late 2001 optimists have until recently outweighed pessimists in the Industrial sector while there has been a preponderance of pessimists in the construction sector. In December, however there was another slight excess of pessimists in the industrial sector as the 6.7% excess of optimists in November fell 7.4 percentage points to 0.7% excess of pessimists. The 6.5% excess of pessimists in the construction sector in December was 2.0 percentage points above November but it was 12.5 percentage points lower than that of December, 2004.