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I've been following the same thing for quite some time. It seems to defy conventional wisdom, which tells that an Interst Rate Inversion ALWAYS is followed by a recession. A few thoughts:
The short term rate is more determined by FED policy, while the long term rate is market driven. The long term market doesn't seem to think inflation is a big deal.
Past inversions have been much steeper than the current one. The current one is almost flat rather than inverted.

I agree with Pawnking that the curve, taking out the fed funds rate, is essentially flat. I am no expert on the bond market but it seems to be saying that interest rates wil remain stable for a long time or will decline. On a total return basis it makes no sense to go long on the ten year otherwise.

The Treasury yield curve over the past six months is best described as flat to mildly inverted. Using the method developed by the Fed's Jonathan Wright, which incorporates treasury yield curve data and the level of the Federal Funds Rate into its calculations, the probability of a recession occurring in the next 12 months has been hovering between 48-52% for the last six months.

You can do the math for yourself here: http://tinyurl.com/qkqb2

Here's an interesting question: While an inverted yield curve is often an early sign that the U.S. is trending toward slower growth (or even recession) in the near term, does a relatively flat yield curve really represent an optimum condition for the economy?

That is an interesting question, Ironman. I suggest the yield curve is one of several indicators about economic health. Granted, it's probably the most quoted though the employment rate, private non-residential investment and corporate profits, to name a few, are others to look at. All except PNRI which is trending down, are in good shape for now.

What I see is the market taking an even keel approach. I do not know if that translates to an optimum.

However, if we were to enter a phase in which rates remained relatively steady, I think that would be very good indeed.

Long end = best credits. Short end = good and bad credits. The government competes with all types of credits on the short end because even unprofitable firms can borrow short-term using assets acquired in the good times as collateral. When the Fed raises rates, it causes some firms to be short liquidity. Weaker firms have to move to short-term borrowing as lenders restrict their offerings. So the government competes with fewer firms on the long end while the short end gets filled with borrowers.

It's important to realize, that the yield curve signals ** structural liquidity changes ** by the chosen actions of market participants which is far more accurate than any other reporting method (after-the-fact financials, whatever) and tends to precede the disclosure of "facts" related to the credit crunch. For example, the yield curve inversion came some time before the implosion of subprime lenders ...

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