We have been hearing quite a bit about a double-dip recession lately. Off the top of your head, do you know the last time we had a double-dip recession? The most recent period in which a double-dip occurred was a three-year span from 1980 through 1982. Out of 36 months in that period, the economy spent 24 months in recession. The first was a short and mild recession lasted from Jan - July 1980. Then there was moderate economic growth until July 1981 when the economy fell into recession again, That one was a severe recession which continued until November 1982.
Technically, that was not a double-dip though because the National Bureau of Economic Research (NBER) considers those to have been two separate recessions. In my view that is just statistical quibbling. Having lived through that time period, it certainly felt like a continuous recession. Therefore, I accept that a double-dip recession is possible, but is one likely now?
Predicting recessions — the Treasury Spread
The Federal Reserve tracks one indicator very closely to determine the likelihood of a recession and that is the spread between 90-day Treasury bills and 10-year Treasury bonds. The difference or spread between the two rates, currently just under 3%, is called the yield curve. When Treasury bill rates are lower than Treasury bond rates, we have a positive yield curve. When T-bill rates are higher than T-bonds, then we have an inverted or negative yield curve. Right now, we have a positive spread or yield curve with T-bills at 0.17% versus 10-year Treasuries at 2.96%. The difference between the two rates is high so this is called a steep yield curve.
This table of daily interest rates for Treasury securities ranging from very short to very long in terms of maturity. Three month (90-day) Treasury bills yield only 0.17% versus 10-year T-bonds at 2.96%. That spread, 2.79%, is considered a steep spread or yield curve.
July 2010
Source: U.S. Treasury
I took a look at these same rates from 2007. Back then, short-term rates were just over 5%, higher than 10-year bonds at 4.68%. Therefore, we had an inverted yield curve:
Starting January 2007
Source: U.S. Treasury
The Federal Reserve uses this yield curve information to predict the probability of a recession. A flat or inverted yield curve is viewed as a predictor of a recession. A steep yield curve is viewed as predicting economic growth with a very low probability of recession. Take a look at this chart that tracks the probably of a recession as indicated by the Treasury spread:
Source: Carpe Diem
This chart shows (blue line) the probability of a recession. As short-term rates rose in 2006 and 2007, the blue line went up indicating the probability of a recession was getting higher. Now, the probability of recession is low, close to zero actually. That is, no recession in sight according to this indicator.
Is a double-dip recession the end of the world?
Now, before I get flamed in the comments, I need to make one thing clear. The economy is not good now. High unemployment, low business confidence and many other factors suggest the economy is slowing.
Though painful, a sluggish economy or even a double-dip recession is not the end of the world. The last double-dip recession happened in the period from 1980 to 1982 when Fed Chairman Paul Volcker raised interest rates way, way up. There was a mild recession in 1980 and then, shortly thereafter, a much steeper recession. Once we got through the second recession, the economy began a long and strong economy recovery that lasted for many years.
We have already suffered through a steep economic downturn. If we do enter another recession, it is likely to be mild. I do not think a double-dip recession is likely. Normally, before a recession begins, the yield curve flattens or even inverts such that T-bills have higher yields than T-bonds. We are not even close to that now and, with T-bill rates at essentially zero, a flat or inverted yield curve is impossible unless you think Treasury bonds are going to zero.
Nonetheless, if enduring a double-dip recession is what it takes to usher in a long period of economic growth, then that would not be a bad tradeoff in my view.
Arturo Estrella, Professor of Economics, at the Rensselaer Polytechnic Institute has a nice web site that has much more on this yield curve issue. For a table showing the dating of all recessions, go here to the National Bureau of Economic Research.
Hat tip: Carpe Diem
Error message
Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.
Copyright © 2009 MarketWatch, Inc. All rights reserved. By using this site, you agree to the Terms of Service and Privacy Policy.
Intraday data provided by Interactive Data Real Time Services, a division of Interactive Data Corp. and subject to terms of use. Historical and current end-of-day data provided by Interactive Data Pricing and Reference Data. More information on NASDAQ traded symbols and their current financial status. Intraday data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. Dow Jones Indexes(SM) from Dow Jones & Company, Inc. SEHK intraday data is provided by Comstock and is at least 60-minutes delayed. All quotes are in local exchange time. Real-time last sale data provided by NASDAQ.
Read Full Article »