What The Yield Curve Is Telling Us

Rarely do economists insist they have a foolproof method for predicting future economic activity, but these days more and more prognosticators are putting their faith in the signals being sent by the yield curve--a simple, connect-the-dots rendering of where interest rates are along the maturity spectrum from 3-month Treasury bills to 30-year Treasury bonds. Trouble is, much like a Rorschach test, different people looking at the same curve come up with different economic forecasts. Some believe the yield curve is saying growth will slow down in the second half. Others believe it's predicting a sharp slowdown or even recession by early 1996. And an academic who did extensive yield-curve analysis in the 1980s says the curve is telling him that growth will be fairly strong in 1995.

Disagreement comes over the significance of one incontrovertible fact--that the yield curve has been flattening lately. That means short- and medium-term interest rates have been moving higher, while long-term rates have been steady. Historically, such a flattening of the curve has predicted slower growth, while an inversion of rates--when short-term rates move above long-term rates--has signaled a recession to come.