Negative yield curves presage every recession and steeply positive ones are necessary to pull the economy out of a downturn. Positive curves work because they rebuild bank balance sheets and punish investors for holding cash. An interesting facet of post-industrial America (the U.S. economy since the 1980-82 recession) is that each recession has needed successively steeper yield curves to move the economy forward. Rather than look at the spread of 10-year Treasury yields to 2-year or 1-year yields I charted the ratio. I did it this way because the sharp decline in the yield environment means that a basis point of spread is worth more today. The steepening necessary for this recession, to the surprise of no one, is staggering.
There any number of reasons why steeper and steeper yield curves have been needed but my favorite is that the financial sector has effectively become the economy's core and the positive curve is a government bailout -- so why not take bigger risk the next time around. It would be nice to say that the current episode is the end of a trend but with re-regulation fading and too-big-to-fail banks getting bigger and a huge Federal deficit requiring the real yields to attract foreign capital, my guess is the end isn't here.
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