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Let's do the twist
IRWIN KELLNER
Commentary: Yield curve returning to normal
By Dr. Irwin Kellner, MarketWatch
Last Update: 1:10 AM ET Mar 7, 2006

HEMPSTEAD, N.Y. (MarketWatch) -- Don't look now, but the yield curve appears to be twisting back toward its normal positive slope. Now the question becomes: is this good news or bad news?

The answer: it all depends on who you are.

If you're looking to take out a fixed-rate mortgage, the recent jump in long-term interest rates to multi-year highs is clearly bad news. It's also bad news for homebuilders, or anyone looking to sell a home, for that matter.

Over the past few months, with most of the increases in interest rates at the short end of the curve, the market for new and existing homes has already begun to weaken, so you can imagine what higher long-term rates will do.

Of course, if you're in the market to buy a home, and you have the financing all lined up, you are in the driver's seat, able to strike a better deal than, let's say, this time last year. In other words -- housing's already become a buyer's market, and these recent increases in bond yields only make it more so.

Since it is a borrower as well, Washington will pay more to float long-term debt -- especially now that it has revived the 30-year bond. Needless to say, the thought of higher yields has gladdened the hearts of many a pension fund and other long-term investors.

For the banks, it's a mixed bag.

On the one hand, those institutions that have a huge mortgage department will find that it will soon get more difficult to make loans. On the other, if and as long-term rates rise above short-term rates, the pressure on their profit margins for other types of loans will ease.

As you know, the rates banks pay for their deposits are akin to those on the short end of the curve. Their loans are priced at rates found on the long end.

When the curve inverts, as it did a number of weeks ago, it squeezes the banks' profitability on a lot of the loans they make. That's why most banks prefer to operate in an environment that contains a positively-sloped yield curve, which it looks like they might get.

But the best news of all is for the economy. That's right; the jump in bond yields is actually good for the U.S. economy.

First of all, by twisting the yield curve back to a positive slope, it puts the banks back into the money-creation process, thus reducing, if not eliminating, the possibility that a recession might develop.

In the past, whenever the curve has inverted, for whatever the reason and at whatever level of interest rates, a recession has followed within months.

Second, and just as important, rising bond yields make the Federal Reserve's job of slowing the economy easier. This means that Ben Bernanke and his band of merry central bankers will not have to raise the federal funds rate as much as they might have had the curve remained inverted.

As long as bond rates continue to rise, I'll stick with my forecast of just two more quarter-point hikes to five percent.

Dr. Irwin Kellner is chief economist for MarketWatch. He also is the Weller professor of economics at Hofstra University and chief economist for North Fork Bank.