Unexpectedly Intriguing!
July 3, 2007

What a difference six weeks make! Once again, the Federal Reserve left the Federal Funds Rate unchanged at 5.25%, but this time, the U.S. Treasury yield curve rates look a lot prettier!

Instead of the inverted condition that predominated most of the last year, the yield of the 10-year Treasury moved solidly above the yield of the 3-month Treasury earlier this month, greatly reducing the probability of recession occurring in the next 12 months. The following chart visualizes the change in probability level:

Probability of Recession, Tracking from 6-23-2003 through 6-28-2007

Using the one-quarter averages of the U.S. Constant Maturity Treasuries and Federal Funds Rate, we find the probability of recession occurring in the U.S. in the next 12 months to be 38.1%, down sharply from the level of 49.3% just six weeks ago.

Meanwhile, using the most recent daily-discounted yield data of 4.62% for the 3-Month Treasury and 5.08% for the 10-Year Treasury with the Federal Funds Rate of 5.25%, which gives an indication of the direction in which the probability of recession is heading, came in at 24.8%.

You know, if the Fed were inclined to raise interest rates to combat inflation, they now have a lot more room to maneuver.


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