Watch out for (yield) curves: Kudlow vs. Goldman

December 23, 2009

The super-steep yield curve is hinting at a powerful recovery in 2010, so says Larry Kudlow:

When the curve is wide and upward sloping, as it is today, it tells us that the economic future is good. When the curve is upside down, or inverted, with short rates above long rates, it tells us that something is amiss — such as a credit crunch and a recession.

The inverted curve is abnormal, the positive curve is normal. We have returned to normalcy, and then some. Right now, the difference between long and short Treasury rates is as wide as any time in history. With the Fed pumping in all that money and anchoring the short rate at zero, investors are now charging the Treasury a higher interest rate for buying its bonds. That’s as it should be. The time preference of money simply means that the investor will hold Treasury bonds for a longer period of time, but he or she is going to charge a higher rate. That is a normal risk profile.

The yield curve may be the best single forecasting predictor there is. When it was inverted or flat for most of 2006, 2007, and the early part of 2008, it correctly predicted big trouble ahead. Right now it is forecasting a much stronger economy in 2010 than most people think possible. So there could be a mini boom next year, with real GDP growing at 4 to 5 percent, perhaps with a 6 percent quarter in there someplace. And the unemployment rate is likely to come down, perhaps moving into the 8 percent zone from today’s 10 percent.

Unless it isn’t, as David Goldman predicts:

The yield curve is at record steepness. I think that’s an overreaction. In fact, the steep yield curve in the present environment is NOT a harbinger of recovery — it’s a brake on recovery because it encourages banks to own Treasuries rather than risky assets.

Goldman then goes on to list 9 other reasons why he doesn’t think the recovery will be particularly strong.


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Kudlow is a congenital optimist and I’ve always admired his insistence on seeing the glass as half full. But when optimism morphs into ideology – the way it seems to have done with him – than the buyer needs to beware.

I think it’s fair to characterize the recent downturn as being different from a ‘garden variety’ recession – after all, most recessions don’t take us to the brink of economic collapse. So from that perspective, a traditional interpretation of the current yield curve may not be forecasting the robust economic growth it often has in the past.

In particular I note the anemic Q3 GDP number that was revised downward twice. Given the depth of the recession, we could have expected a much stronger number. Sure, Q4 may give us a boffo number and if anyone wants to make that bet that’s fine. Just don’t do it based on Kudlow’s version of Rosey Scenario.

Posted by Bill, Fairfax, VA | Report as abusive

I have always liked Larry Kudlow’s optimistic view of the future and, frankly, I see nothing wrong with his analysis of the current yield curve. David Goldman, on the other hand, is a classic bond trader, forever bearish and always looking for clouds on the horizon, however small, to justify heading indoors. As for this current recession being “different”, as in “It’s different this time” – oh please. The equity rally of the late 90’s, the real-estate boom of the mid-00’s, virtually all the pundits said it was different this time. Of course they were all proven wrong, spectacularly so. Bet on inertia, bet on human nature, bet on optimism: Larry Kudlow has it right, once again.

Posted by gotthardbahn | Report as abusive