Thursday, August 26, 2010

Chances of a Double Dip?

Anybody following the markets know that everybody thinks the chances of a double dip recession has increased dramatically of late. Incredible considering double dips have only happened 3 times in the last 100 some years. Notable doom and gloom expert Roubini upped his estimate to 40% via a tweet yesterday.

Why is there so much gloom considering the best indicator of all time signals that odds are nearly 0%? The Yield Curve has always been the best indicator of booms and busts yet they seem to get ignored all the time. During a boom, negative yield curves get brushed aside. During rough patches, they are assumed not useful this time based on the particular crisis of the time.

The New York Fed produced these charts showing the predictive ability of the spread between the 10 year Treasury bond and the 3 month T-bill. The very positive yield curve predicts a virtually impossible chance of a double dip this time around. Notice how the chances of a double dip in the early '80s was nearly 100%. That was the last time the US economy had a double dip recession and the conditions were completely opposite back then.

Of course, it could be different this time. The housing market was so weak in July that everybody has become uber-bearish. Considering the weakness was mainly contributed to the expiring tax credit, its hard to understand the bearish concern. If anything, housing is likely to pick up going forward. Its already rock bottom and interest rates will only continue to drop and fuel demand if it doesn't pick up.

Yes, this time around a China collapse could damage the US economy or lower mortgage rates just aren't going to work in a tighter credit market. That's all possible, but typically that's how the yield curve gets so positive. The more negative factors the wider the yield curve. Just the opposite happens when the yield curve goes negative. As in 2007, the economy and specially housing was booming so much that the Fed raised rates in order to cut off spending. Bingo, finally the negative yield curve finally tipped the market over. Just like then, now the yield curve will remain full on bullish until the economy recovers.

Don't fight the Yield Curve. Its never different!

No comments: