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Cantor predicts yield curve could invert
Top bond broker says short rates could soon exceed long rates -- which often precedes recession.
July 8, 2005: 3:53 PM EDT
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NEW YORK (CNN/Money) - One of the world's largest Treasury bond brokers has predicted that the so-called yield curve could invert by as early as the next quarter, a move some economists fear could precede a recession.

If the federal funds target rate hits 4.25 percent by the end of the year, the yield on the two-year note is likely to rise to 4.25 percent, as well, said a research note from John Herrmann, head of economic commentary at Cantor Viewpoint, a unit of Cantor Fitzgerald.

But the yield on the 10-year note was forecast to end the year at about 4.15 percent, not far from current levels.

The report said there was only a 20 percent chance that federal funds target rate would hit 4.25 percent, but the forecast made the top Treasury bond dealer one of the first voices to formally expect an inversion in the curve.

The yield curve refers to the upward sloping graph that's normally depicted by bond yields in the Treasury market: the yields on shorter maturity debt are lower than those on longer maturities.

Curves and conundrums

When short-term yields become higher than long-term yields, it is called an inverted yield curve. An inverted yield curve has preceded the nation's last two economic recessions. (Confused about yield curves? Click here for help.)

The Federal Reserve has boosted short-term interest rates nine straight times since last June to 3.25 percent, and the central bank gave little indication that it would pause its monetary tightening campaign when it again raised last week.

Despite those increases, long-term Treasury yields have not risen in kind and are in fact below where they were when the Fed started raising short-term rates last summer.

Fed Chairman Alan Greenspan has called that a conundrum, and economists have struggled to predict whether the Treasury market is set to tumble, which would push yields higher. Bond prices and yields move in opposite directions.

Long-term yields have remained low despite a year of fed fund rate hikes, causing short- and long-term yield levels to move closer together. This is known as a flattening yield curve.

Traders may have held onto bonds in the face of rising short-term rates because they believe the hikes mean the Fed has inflation well in hand. Inflation hurts bonds by eroding the value of the fixed-income investment.

When the yield curve inverted in 2000, two-year yields exceeded 10-year yields by a little more than half a point. Cantor's recent forecast has pegged the two-year yield ending the year a quarter point higher than the 10-year yield.

But the firm said in its report that it believes the economy is "continuing to exhibit surprising economic resilience."

Cantor Fitzgerald later named five factors that would keep an inverted yield curve at bay. Click here for more.

For more on the yield curve, click here.

To see what bonds are doing today, click here.

And click here for bond charts.  Top of page


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