Top Forecaster Predicts A Recession
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The U.S. bond market’s most accurate forecaster, who plies his trade 500 miles from Wall Street, says yields are sending ominous signs about the economy.
While economists at the biggest bond-trading firms wrongly predicted that the benchmark U.S. 10-year Treasury yield would end last year at 5%, a University of North Carolina at Chapel Hill professor came a lot closer to getting it right.
“It was luck, partly,” said James Smith, 67, who teaches finance at the school. “The other reason is the anticipation that inflation would be contained and that continued rate increases from the Federal Reserve would keep longer-maturity investors enthused about their returns.”
Mr. Smith turned out to be the top forecaster in Bloomberg’s January survey of 66 economists. He predicted the benchmark 10- year yield would end the year at 4.49%. At the time, the yield was about 4.27% and the median estimate was for it to climb to 5.04% by December 31. It finished 2005 at 4.39%. Yields move inversely to bond prices.
“Those Wall Street gurus have bigger expense accounts than I have total income,” Mr. Smith said.
Mr. Smith said the bond market is waving a caution flag on the economy. Two-year Treasury yields last week rose above those on 10- year notes, creating a so-called inverted yield curve for the first time since December 2000. An inversion preceded the last four recessions in America.
“When the curve inverts, run for the exits,” Mr. Smith, who served as an economist for the Fed from 1975 to 1977, said. “It will stay that way until the Fed realizes it caused a recession in 2007. Investors should start planning for a recession.”
The 10-year yield will climb to 4.53% this year, Mr. Smith predicts. His forecast is again below the median estimate of economists, which is for the yield to end 2006 at 5%, according to a survey from November 30 to December 8.
Core inflation, which excludes food and energy prices, “remains under control,” he said, tempering any rise in yields. Inflation erodes the purchasing power of a bond’s fixed payments.
Mr. Smith is a professor at the Kenan-Flagler Business School at UNC.
