The Federal Reserve's war against inflation passed a milestone this week as short-term rates exceeded long-term rates by one widely watched measure for the first time since April 1982.
The historic reversal Tuesday was a cause for celebration by many economists and market watchers, who said it indicated that the Fed is succeeding in getting inflation under control."The ultimate message is that markets expect future inflation to be lower than current inflation," said Lawrence Kudlow, chief economist of Bear, Stearns & Co.
Some other analysts said the switch could spell trouble, noting that past flip-flops in short- and long-term rates often reflected credit crunches that led to recessions.
Long-term rates are ordinarily higher than short-term rates because investors demand higher yields in return for the risk of keeping their money locked up for longer periods.
For the last year, though, short-term rates have been rising and long-term rates falling, trends that culminated in Tuesday's flip-flop.
The rise in short-term rates has been brought about by the Federal Reserve, which uses the higher rates to discourage borrowing, cool off the economy and prevent inflation from getting out of hand.
Meanwhile, the Fed's tactics have won the confidence of inflation-wary investors. Since they are no longer demanding such a big premium to keep their money tied up in bonds, long-term rates have fallen.
The so-called inversion of the yield curve occurred Tuesday morning. By midafternoon, the yield on the Treasury's three-month Treasury bill was at 8.82 percent and the yield on the benchmark 30-year bond stood at 8.80 percent.
By some other measures - say, comparing yields on the 30-year bond and the one-year note - the inversion in yields had already occurred.
Kudlow said the inversion in yields signals a decline in inflation that will be good for both stocks and bonds.
Skeptics say the Federal Reserve does not have a delicate hand on the tiller of the economy and is very likely to cause a recession by pushing short-term rates too high.