Monday, June 6, 2011

No Double Dip According to Treasury Spread

Mark Perry's Carpe Diem blog had a great little post on the recession predictive ability of the Treasury Spread. The New York Fed has a great chart that I've used in the past that predicts the possibility of a recession over the next year based on the treasury spread between the 10 year bond rate and the 3 month bill rate.

As the chart shows, the possibility of a recession is below 1%. It just doesn't seem to happen when the treasury spread is this large. The market is increasing worried about a recession even though it just isn't likely under the current monetary circumstances. Clearly when an economy hits a soft patch as it did during April and May, the slant of the yield curve is hugely important in determining the next move whether up or down.

With such a positive curve at over 3%, corporations and investors are encouraged to take on risks and in essence buy the dips. While a negative sloping yield curve causes the reduction in borrowing and business expansions hence leading to a recession. Remember, savers get zero interest putting money in banks. They either have to loan it to corporations for expansion or make investments in businesses or the stock market in order to enjoy a decent return.

Based on the NY Fed chart, it seems very apparent now that the economy is in nothing more than a soft patch caused by the combination of the Japan disaster and the bad weather not only in the US but around the world such as the flooding in Australia.

What I find truly amazing is all the negative comments back on the Carpe Diem post. The facts of the chart and logic speak very loud and clear. Such negative psychology makes me more bullish. It appears that a vast majority are readying for a double dip just like in 2010.

The market has now been down for 6 straight weeks counting this week. Also, the Dow/SP500 have had 4 straight losing sessions for the first time going back to August 24th, 2010. Interestingly that was right before the market surged and risk assets had a huge September and didn't really stop until February in most cases. Could this be round 2?

Market is cheap, monetary policy is insanely positive, and now investor sentiment is turning very dour.

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