The yield curve is flat

Not long ago I threw a wet blanket on the rosy sentiments we've been hearing from economists by pointing out the very, very low personal savings rate. Now I've got some more bad news: the yield curve is flat, and for some debt instruments, it might even be slightly inverted.

Looking at the 6-month bill, the yield is 4.98%. Same as the 2-year note, and just 0.01% below the yield of the 3-year note. If you increase the maturity to 5 years, the yield only goes up to 5.03%. Even the 30-year bond is only a quarter of a point more. (Looking outside the U.S., the U.K. government bond yields are seriously inverted, with 3-year yields fully half a percentage point higher than you'd get with a 30-year maturity.)

I also checked CD rates at LaSalle Bank. The 30-month CD has a yield of 4.90%, but the 3-year certificate actually has a lower yield -- only 4.85%.

Normally, you'd expect rates to go up as you increase time to maturity. After all, if you expect rates to be relatively stable over time, you'd want to get a better return (the "liquidity premium") in exchange for letting the bank (or the Treasury) hold onto your money longer. But right now, people are paying a premium for longer-term debt. Why?

One possibility is a flight to quality in long-term debt; U.S. Treasury bonds are considered very safe and have very little maturity risk premium. But another possibility is that investors are pessimistic about the U.S. economy, despite all the upbeat talk. They expect short term rates to fall as the result of an imminent recession, and should this happen, the yield curve will right itself. This does not bode well for the economy. Recession = BAD.

It could also be that long-term debt turns out to be overpriced, especially as the Treasury churns out more of it to finance the deficit. In this case, long-term rates will go up, which could be a disaster to bond investors as the value of their bonds fall in inverse proportion to rising interest rates. It's not so good for the rest of us, either. Higher interests rates tend to suppress economic growth.

Disclaimer: What do I know? I'm no economist, and I'm not a financial advisor, so you shouldn't be making your investment decisions based on what you read here.