Double-Dip Recession? The Yield Curve Says NoWhile it's certainly popular to say the U.S. economy is heading toward a double-dip recession, the simple reality is that we're still in the first one that started in December 2007, as I told Portuguese economics blog Janela na web (Window on the Web) in an interview in June. That's because the National Bureau of Economic Research (NBER), which officially declares the beginnings and ends of recessions, says that the job losses that started in December 2007 are still with us.

Still, I can understand what most people are referring to when they talk about a double dip. We've had positive GDP growth since the fourth quarter of 2009, and the fear is that this growth will turn negative.

But the yield curve -- the interest rates paid on different durations of Treasury bonds -- is sloped upwards so much that the chances of such a double-dip recession are a mere 15.5%, according to the Federal Reserve Bank of Cleveland.

How The Yield Curve Predicts The Economy

The theory behind the yield curve is well-explained in William Greider's 1987 bestseller about the Federal Reserve, Secrets of The Temple. The Fed sets short-term interest rates and the market sets the longer-term ones. These differing rates over time can be depicted as a curve that either slopes up or down. If the yield curve is positive sloping -- in other words, when short-term rates are lower than long-term rates -- then the economy is likely to expand.

That's because under those conditions, banks will be rewarded by the spread between rates for borrowing money in the short-term and lending it out for later repayment. Simply put, an upward sloping yield curve makes it profitable for banks take money at a very low rate and to lend it to business and individuals who will repay it later at a higher rate. Such lending generally puts more money into the economy and leads to economic growth.

Conversely, when the Fed wants to cool off an overheated economy, it raises the short-term interest rate to the point where the yield curve slopes down -- creating a so-called inverted yield curve. When this happens, the spread I mentioned above turns negative and it is more profitable for banks to hold onto their cash.

How so? If they were to lend it out under such conditions, they would be paying a higher interest rate to attract deposits than they would receive from people to whom they lent it out. Under those conditions, rather than lose money on lending, banks will hoard their cash. That reduction in the amount of money flowing into the economy induces an economic slowdown.

What The Yield Curve's Saying Now


Today, this theory predicts an economic expansion, because, as Bloomberg reports, the gap between 2-year and 10-year Treasury notes -- the short and the longer term durations -- is 2.11 percentage points. While this spread is narrower than February 2010's record 2.91 percentage point spread, it's nearly double the average since 1990. In other words, we have a very positive yield curve now.

Bond traders note that the last seven economic contractions have been preceded by an inverted yield curve, so they're not buying the idea that a downturn is imminent. But if we're not heading into a recession, how much will the economy grow? The Cleveland Fed's projections of the three-month Treasury bill rate to 10-year note yield suggest slow, but positive economic growth -- up 1.14% over the next year.

If that turns out to be right, there won't be a double-dip, but it won't feel much like economic growth. And if that slow growth leads to a moribund job market, it may take more than a year for us to get out of the recession that NBER said started in December 2007 -- and that's still, technically, going on.

Increase your money and finance knowledge from home

What Is Your Risk Tolerance?

Answer the question "What type of investor am I?".

View Course »

Introduction to Preferred Shares

Learn the difference between preferred and common shares.

View Course »

Add a Comment

*0 / 3000 Character Maximum

37 Comments

Filter by:
Melanie

Bush's fault. Obama's fault. Democrats. Republicans. Wouldn't it be great if the few great minds in our nation's capitol put together an acceptable plan to get us out of this mess? Just wishful thinking...

August 31 2010 at 7:12 AM Report abuse rate up rate down Reply
pacedr

Wait until the Obama tax increases kick in at the beginning of 2011. You think the economy is slow now, our Chief Community Organizer is going to show us just how much damage a rookie can do in the White House. Incidentally, if the economy goes into a depression after the first of the year, will that be a double-dip recession or just an extension of the original recession?

August 24 2010 at 2:36 PM Report abuse rate up rate down Reply
fsanello

When are our so-called representatives in Congress and the Senate and our incompetent president going to take action to end this disgraceful 2 1/2 year-long recession. Obama will not win reelection in 2012 if the job market has not improved dramatically by then. Remember how populare George H.W. Bush was after winning the Gulf War? Six months after victory, the U.S. economy was in a deep recession, Bush's popularity plummeted, and he was tossed out of the Oval Office. The Democrats will lose control of the Senate and House in the 2010 mid-term elections, but does anybody believe the Republicans will be able to bail us out of the current recession? It was George W. Bush's insane tax cuts for the super rich which created a huge budget deficit. Our economy can't flourish with a huge deficit. The major reason the economy boomed during the Clinton administration is that the president balanced the budget and left office and the nation with a budget surplus. Bush promptly blew the surplus by cutting the taxes of millionaires. Aux barricades! Frank Sanello FSanello@aol.com

August 24 2010 at 12:46 PM Report abuse rate up rate down Reply
dray907023

MORE INFROMATION FROM THE FOLKS THAT TOLD US NO PROBLEM FROM HOUSING 2 YEARS AGO OR THERE IS NO SUCH THING AS A RECESSION OR BUY A HOUSE TODAY THE PRICES WILL NEVER DROP AND NOW THERE IS NO SUCH THING AS A DOUBLE DIP RECESSION .

August 24 2010 at 12:08 PM Report abuse +1 rate up rate down Reply
Cherie

A ((((Depression)))) is a (((Recession))) that lasts two years. Sugar coating it by saying double dip is a spin, slant to keep up the so called Summer of Recovery. Housing market is down, unemployment is high, our gross national product is weak. So time for Democratic 3 D's. Diversion, Distraction Drama. Because the cure for them was tax and spend and we see how well that is working.

August 24 2010 at 10:51 AM Report abuse +4 rate up rate down Reply
LEE Resolution

Just keep running the campaign on former President Bush's record, and when the avalanche hits the lefties in November and control returns to the GOP, blame the loss on Bush. Now that will be accurate and well deserved because already Americans are longing for the days when they believed what the president (Bush) was saying to them.

August 24 2010 at 10:30 AM Report abuse +3 rate up rate down Reply
LEE Resolution

fixitright73 9:54 AM Aug 24, 2010 * (0) vote this comment up * (4) vote this comment down * FOX news and the corporatist fascist control the ecomony ************* another gem of economic 'brilliance', posted by a far lefty who obviously holds a senior fellowship chair somewhere in one of the world's leading institutions of learning. See full article from DailyFinance: http://srph.it/b3WF24

August 24 2010 at 10:27 AM Report abuse +2 rate up rate down Reply
fixitright73

FOX news and the corporatist fascist control the ecomony

August 24 2010 at 9:54 AM Report abuse -8 rate up rate down Reply
1 reply to fixitright73's comment
tjdwil

Is that going to be the Obama campaign platform in '12 ? ,,,,,,,,,,It's Fox New's fault, and all those corporate fascist, that are funding my campaign ?............ And here I thought it was all Dubya's fault. How about you guy's change your party name to the " Victim Party"

August 24 2010 at 10:10 AM Report abuse +2 rate up rate down Reply
Mike Sr

I say "no" also because although we are not technically in a recession as defined by so many consecutive negative quarters in GDP, we really never emerged from the first recession. IMO< we will not be in true recovery mode for years to come if ever. The current economic statistics as they pertain to unemployment rate, housing, etc. may truly have become the "new normal." Add to this the time is coming soon when inflation will rear its ugly head and the Economy will really be in a tizzy. Regrettably for 401-k's, I do not expect a recovery in stock prices any time soon either. I'll wager that we will end 2010 well below 10,000 in the DJIA. So Mr. Cohan, methinks that you are way off base when you predict an upturn in our Economy.

August 24 2010 at 9:53 AM Report abuse +2 rate up rate down Reply
ksmwtm

This 'In the box' analysis fits this EX-tra Ordinary, Unique, financial mess HOW? Reverse logic this from how bankers think to HOW Company Management thinks. Profits are in a range stockholders will accept, & expanding now introduces risk that may cost mgt. their jobs, if economics GUESSES are off target--which is usual as there seems a necessity for regular revisions to data. What is the risk
eward for leaving cash bountiful security for a questionable yield amount? A year to recovery? Try 2 or 3 yrs. of this morras.

August 24 2010 at 9:44 AM Report abuse rate up rate down Reply