Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, July 04, 2005

The Yield Curve Conundrum

Why is the yield curve flattening out so much?

Here is a portion of Ben Carliner's discussion of recent Fed policy

Inasmuch as speculators interested in flipping properties are much more likely than long term buyers to use ARMs [adjustable rate mortgages] and interest-only mortgages to finance their borrowings, continued monetary tightening could take some of the pressure off the unsustainable rise in real estate values. Of course, this assumes that home buyers aren’t already so pressed by high prices that they are using ARMs simply because they couldn’t afford their monthly payments at the higher 30 year fixed rate. Either way, a new wave of mortgage refinancings is now likely, which will continue to drive consumer spending and domestic economic growth. Recent research from Dresdner Kleinwort Wasserstein shows that the amount of equity taken out and not reinvested into real estate rose by $202 billion in the past year ending in March.

As for the yield curve conundrum, it shows no sign of abating. The chart below speaks for itself.

One possible explanation is that continued tightening by the Fed has reduced long-term inflationary expectations, thus lowering long-term nominal rates via the Fisher equation:

nominal rate = real rate + expected rate of inflation
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