Rosenberg argues the nominal yield curve would be inverted right now if it were not for the fact that short term rates are essentially at zero. The Treasury shows the Friday July, 9 nominal yield curve as:
|Date||1 mo||3 mo||6 mo||1 yr||2 yr||3 yr||5 yr||7 yr||10 yr||20 yr||30 yr|
If we assume that expected inflation for the short term is (say) -3, that is, that deflation is expected over the short term, but that inflation is expected to rear its ugly head over the long term (say) + 3, then we can use Fisher’s relation that nominal rates less expected inflation equals real rates, to see that the REAL yield curve could be inverted right now:
2 year Short term nominal (.63) – expected deflation (-3.00) = 3.63 real
30 year Long term nominal (4.04) – inflation (+3.00) = 1.04 real
If the real yield curve is inverted, it’s an ominous sign…
Market Ticker often posts this graph of total debt (public and private) in the US:
We can see from that graph that the trend is now changed to “down” after 50 years of “up”. The Federal government has been unsuccessfully attempting to offset the decline in private debt with increases in public debt. With the trend to more austere budgets, the growth rate in Federal debt will also begin to decline, accelerating the decline in total debt. What does this mean for interest rates? A shrinking supply of total debt means there is a shrinking supply of debt securities in which investors can invest. All other things held constant, this implies that debt prices will be bid up and interest rates down. In the case of US Treasury debt, we can expect a significant fraction of it to be monetized – bought by the Federal Reserve and paid for with Dollars that don’t cost the Treasury any interest. This monetization process will not increase the total amount of dollars available, but it will further reduce the supply of interest bearing debt instruments available for investors to buy – resulting in still more upward pressure on Treasury prices and downward pressure on rates. There appears substantial probability that long term Treasury Bond rates could be cut in half (from 4 to 2%) within 18 months. Only when the private economy begins to recover with real, non-government financed growth will we have significant risk of a rise in interest rates.