Long term yields flat for 4 years, but short term rises?

Question

The yield curve since 2003 has maintained a level of about 4.5% at the very long end, but has gone from a rising yield curve to a falling yield curve due to short term changes. Does this mean that expectations of long term inflation have not changed over the last 4 years, and therefore that any deflation in the economy will be moderate?

Answer 1

The old wisdom about interest rates is exactly as you say: that long rates reflect the perception of deep future inflation and growth. However, the US massively negative balace of trade is offset by a positive flow of cash. In other words, we spend money overseas, while the people who recieve that cash deposit it back in the US for safe investment returns. Foreign cash inflows are what keeps our out of balance economy from imploding. As a result, demand for long bonds is unnaturally high, and I believe that's what's driving the inverted yield curve.

In this environment, all bets are off: we've had an inverted yield curve for months, and yet the economy is very strong. This is what Greenspan referred to as a "conundrum", but I don't see the mystery. The byproduct of our trade policy (or lack thereof) is a disconnect between short and long rates.

Answer 2

Long term rates are the rates on long term bonds, when there is a lot of money going into long term bonds, the rate drops, because there is a lot of demand (with demand up , prices are up and yield is down). Long term bonds are bid up because people want them, because they think the economy will slow and interest rates drop on the front end (short term bonds) thus making the long term bonds more valuable. A lot of the money in the bond market comes from asia because they have to do something with the billions of dollars the trade deficit from The US. US has about a 700 billion trade deficit per year with the world, the government sells bonds to offset that deficit.

Answer 3

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