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Wednesday, December 28, 2005


the curve inverts

it won't be reported on many (or any) political blogs, but a momentous and forboding event took place yesterday when the american treasury yield curve inverted intraday for the first time since the peak of the nasdaq bubble in 2000.

this page has previously considered the ramifications of this perhaps inevitable day, beginning in february of this year with a definition; in march within the context of financial conditions; again in march with respect more specifically to the carry trade; in september and again in november with regard to the massive global debt/housing bubble.

some depressing voices are can be heard from the wilderness, including that of prudent bear manager david tice and pimco's bill gross, who thinks that extreme weakness in housing over the next few months could stop the federal reserve's program of rate hikes.

what i wrote in september continues to express my view.

the lender, ultimately, is in control of this bubble -- the borrowers of the masses would likely immolate themselves on ever-more debt for so long as lenders grant them the rope with which to hang themselves. it is when the lender -- not the borrower, but the lender -- decides that the terms are no longer advantageous that the bubble will pop. banks will only lend for so long as there is money in lending; even as banks now function only as irresponsible pass-through fee generators, without actually having to profit from interest-rate differentials themselves, a disappearance of buyers for their mortgages (and securities backed with them) will be the consequence of unprofitability in lending long-term with funds borrowed in the short-term -- that is, when the yield curve inverts.
this drying up of the investment end of the carry trade is already being seen in declines in mortgage-backed securities at the riskiest fringes of the market.

this is a warning to the observant. coincident with sharply lower future expectations and declining leading indicators, a bull-flattening curve signals an imminent end to lending expansion in the american economy and the onset of a contraction and recession -- if not worse, given the massive imbalances in the global economy and the need of an immense deleveraging of the kind not seen since the years 1914-45. such an event has been in the wings since the late 1990s, when analytical heads first began to talk about the frightening quantity of borrowing in the global financial system. the federal reserve bank under alan greenspan delayed that deleveraging by radically cutting rates in the aftermath of the 2000 curve inversion and the popping of the global equity bubble. but, in doing so, greenspan opened the floodgate to a massive and unanticipated expansion of consumer borrowing from those already lofty levels, making the eventual inevitable vastly more damaging, painful and uncontrollable -- uncontrollable, particularly meaning the vanishing authority of american policy over global economic management through the dollar, which has become a potential horseman of economic apocalypse.

weathering such a storm as we may be entering without sustaining traumatizing destruction -- globally, nationally and personally -- is a very difficult, perhaps impossible task. i wish you luck, as i hope you wish me luck.
yield curve data is updated daily here.


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