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The Yield Curve Is Signaling Bigger Growth

kudlow-post1What's a yield curve, and why is it so important?

Well, the curve itself measures Treasury interest rates, by maturity, from 91-day T-bills all the way out to 30-year bonds. It's the difference between the long rates and the short rates that tells a key story about the future of the economy.

When the curve is wide and upward sloping, as it is today, it tells us that the economic future is good. When the curve is upside down, or inverted, with short rates above long rates, it tells us that something is amiss — such as a credit crunch and a recession.

The inverted curve is abnormal; the positive curve is normal. We have returned to normalcy, and then some. Right now, the difference between long and short Treasury rates is as wide as any time in history. With the Fed pumping in all that money and anchoring the short rate at zero, investors are now charging the Treasury a higher interest rate for buying its bonds. That's as it should be. The time preference of money simply means that the investor will hold Treasury bonds for a longer period of time, but he or she is going to charge a higher rate. That is a normal risk profile.

The yield curve may be the best single forecasting predictor there is. When it was inverted or flat for most of 2006, 2007 and the early part of 2008, it correctly predicted big trouble ahead. Right now, it is forecasting a much stronger economy in 2010 than most people think possible.

So there could be a mini boom next year, with real gross domestic product growing at 4 to 5 percent, perhaps with a 6 percent quarter in there someplace. And the unemployment rate is likely to come down, perhaps moving into the 8 percent zone from today's 10 percent.

The normalization of the Treasury curve is corroborated by the rising stock market and a normalization of credit spreads in the bond market. I note that as the curve has widened in recent weeks, gold prices have corrected lower and the dollar has increased somewhat. So the edge may be coming off the inflation threat.

If market investors expect the economy to grow, inflation at the margin will be that much lower as better growth absorbs at least some of the money-supply excess created by the Fed. My hunch is that inflation will range 2 percent to 3 percent next year.

It also could be that the health care bill about to pass in the Senate is less onerous from a growth standpoint — and certainly less onerous than the House bill. For example, the Senate bill does not contain a 5.4 percent personal-tax-rate surcharge, which also would apply to capital gains. So if the Senate bill becomes the final bill, it will be less punitive on growth.

That could explain the fall in gold and the rise in the dollar. We'll still be stuck with a tax hike from the expiration of the Bush tax cuts, but at least we won't have a tax hike on top of that. That's the optimistic view, at any rate.

But really, pessimists have missed the big rise in corporate profits, the resiliency of our mostly free-market capitalist economy and the monetarist experiment from the easy-money Fed. The optimal policy mix on the supply-side is low tax rates and King Dollar. We don't have that. So as good as 2010 may be, with investors moving to beat the tax man, it could be a false prosperity at the expense of 2011.

But let's cross that bridge when we get there. Right now, rising stocks and a wide and positive yield curve are spelling strong economic growth in the new year.

To find out more about Lawrence Kudlow and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate web page at www.creators.com.


9 Responses »

  1. So Larry, what have you been smoking? The difference in the rates is manipulated by the Fed. Their continued skewing of bad economic news into positive propaganda is so transparent that even a child can see through it. I won't even get into the usual explanations. If you can't see it, then you have little hope of seeing the trees in the forest. When the government pumps in money to give government employees raises at every level local,city, county, state, federal and the healthcare and university types then you have "no growth". There is only so many taxpayers than can fund this inverse ratio. In other words, a leech can only gorge itself so much before it's host dies. People that the government has funded are consumers not consumer-producers. Read Thomas Paine as he eloquently points out this scenario over two hundred years ago at the inception of our country.

    Good day and Happy New Year's

    John Epperson

    • John Epperson is absolutely correct and Larry is, well Larry.

    • john.....you are so correct....mr. kudlow is nothing but a shill for the plunge protection team in the treasury and toes the government spin...........yes kudlow the economy is wonderful 99 TRILLION in the hole............lets have a bull market with that.

    • John writes, "When the government pumps in money to give government employees raises at every level local,city, county, state, federal and the healthcare and university types then you have “no growth”.

      My sister is a county employee out there in Northern California. I think she might take issue with your statement that goverment employees have gotten raises across the board. WTF are you smoking? I don't know about all govt employess at all levels, but in her case, she and her co-workers not only aren't getting raises, but their pay was effectively cut 14% due to ongoing mandatory furloughs.

      And they , as you say, are "People that the government has funded are consumers not consumer-producers."? Well, people like my sister are the ones who make sure you don't find cockroaches floating in your chowder when you go out to eat in a restuarant. So f_&*k you, a$$hole.

  2. My observations show otherwise, there is nothing normal about this economy. Currently, 67% of the US is dependent on checks from the government. High school achievement is at level not seen since the mid-30's. Nevada has a 40% hs dropout rate. Why is our government denying that things are getting worse? Your arguments would sound far more rational if you were using real interest rates. We are reliving the events that led up to the inflationary period of the 70's. That lasted for more than a decade. Will Bernanke have the intelligence and political will to raise interest rates as Paul Voelker did? I doubt it. Currently, the only buyer of treasury bonds is the US Treasury. That is not normal and every day the Fed is sounding more and more like a pyramid scheme. Inflation is going to kill our savings plans and then its all over for our economy after that.

  3. I agree with Mr. Epperson, Larry is smoking some of that pot they hand out in that bankrupt state of California to people with tourette syndrome. My money (I mean gold) is on the curve showing something entirely different. I will bet that Obama throwing printed money to all in the street to pick up, along with the China not buying anymore treasuries will cause that nasty event called hyperinflation.

    Good Luck Larry buddy


  4. While a wide yield curve has often been a sign of easy money coupled with expectations of long term growth, a green light for the stock market, there is another interpretation of the current curve. Why the short end is anchored (read: manipulated) is obvious - The Fed has pinned it there with it's open market operations. But the long end of the curve is going up not because bond investors expect growth, but becuase they are demanding compensation for the ongoing debasement of the dollar. As Milton Friedman taught us inflation is not a byproduct of robust economic activity, but rather a currency event. As a society we have bought the mythology that inflation is not only not an evil, but actually good for the economy. But it is not. As Buffet and others have noted it is simply a regressive confiscation of wealth

  5. The dollar should be a stable store of value to facillitate commerce. Debasing the currency as a means of economic manipulation is a violation of the constitution. Economic stimulus should be achieved through lower spending and tax reductions. You cant grow an economy by borrowing money.

    The US gov. no longer represents the interest of the people. The two party system has been bought by the bankers. When retirees figure out why their fixed income is running out quicker and quicker before the end of the month, the two party system will be thrown out. Old people bother to vote, and if they care about their quality of life they will supports candidates such as Peter Schiff in CT. and Rand Paul in Kentucky, who seek to protect the dollar and maintain its stabillity. Career politicians are about to be thrown out in droves and the debauchery of the constitution halted.


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