Monday, 15 October 2007

Inverted global yield curve: What does it mean?

Menzie Chinn at Econbrowser notes that based on data from the Economist, 18 out of 33 economies listed in the print edition have 10 year interest rates lower than the 3 month rate. In particular, the US 10 year/3 month spread is now positive but the euro area spread is now negative.

Citing findings from some papers (ECB working paper and Kozicki (1997)), he thinks that there may be reason to worry about the global economy, particularly in places like the euro area, Australia and the UK.

Meanwhile, William Hester at Hussman Funds thinks that an inverted yield curve could mean slower global earnings growth ahead.

Changes in World EPS have tracked the shape of the global yield curve closely, usually with about a two-year lag. The global yield curve was inverted from 1979 until 1982. The smoothed World EPS eventually declined by 10 percent. The global yield curve inverted again in 1990, and World EPS declined by a similar amount. In 2001 when the smoothed yield curve flattened, but didn't invert, World EPS again declined by more than 10 percent. The 12-month moving average of the yield curve spread hit zero in July. It has since ticked up a fraction, as short rates have fallen in response to the world-wide credit crisis.

Hester notes that year-over-year changes in World EPS have very little correlation with the short-term returns of the MSCI World price index. Nevertheless:

...there have been three meaningful declines in smoothed World earnings, bottoming in 1982, 1991, and 2001. Using monthly data, the smoothed Global Yield Curve bottomed in November 1981, May 1990, and April 2001. The corresponding declines in the MSCI World price index from those points were -17.3 percent, -19.4 percent, -35.0 percent, respectively (the peak-to-trough market losses were even worse).

1 comment:

Anonymous said...

Very interesting indeed.

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