Tuesday, December 27, 2005

Inverted Yield curve...

The Yield curve has just inverted!
An "Inverted Yield Curve" means the 2-Year Note Yield moves above the 10-Year Note Yield. But more importantly, history has shown this to be a recessionary signal. We don't see an Inverted Yield Curve signaling a recession this time. Why? Our Fed Funds rate has risen 325bp since June 2004. The 2-Year Note Yield moved higher with the Fed hikes since it is short-term paper. But, the 10-year Note Yield actually moved sideways to lower during this timeframe because of the inflation-fighting mechanism behind the hikes. Longer-term paper is more concerned with inflation rather than actual Fed moves. Bottom Line...Things are different this time because the Fed moves have pushed the 2-Year Note Yield higher, while foreign buying and contained inflation have helped reduce the 10-year Note Yield. The economy is and will continue to be strong and a recession is not in the cards.
Stocks may be set for a "Santa Claus Rally" and a run at the 11,000 mark this week. But first the Index has to break through the 10,940 barrier. This pesky level has been a solid ceiling of resistance for stocks many times during 2005. Each failed attempt to break this level has resulted in stocks dropping and bonds improving. It is no coincidence that mortgage bonds are near a ceiling in their range as well at this time. Bond traders will closely watch stocks to see how they react. If stocks bust above the ceiling, bond prices will drop. But if stocks again fail to break through, mortgage bonds should improve nicely. Remember, stocks and bonds often compete for the same investment dollar.

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