Interest Rates, Yields, Outstanding Debt, and Consumer Attitudes
The yield curve remained inverted in December, with the yield on 10-year Treasury securities nearly 40 basis points below that on the 1-year Treasury bill. An inverted yield curve has been a feature of the data throughout the summer and fall months of 2006. Historically, inverted yield curves have often preceded recessions. However, an inverted yield curve can also be consistent with the Federal Reserve's ability to contain long-run inflationary expectations. For an analysis of the predictive power of the yield curve, see "The Yield Curve's Predictive Power."
Short-term interest rates increased step in step with the federal funds rate during the last round of tightening by the Federal Open Market Committee. Over the two-year round of policy tightening, the 90-day Treasury bill rate increased more than 350 basis points.
Nominal yields on long-term Treasury securities have trended downward since policy tightening ended in late June. Since that point in time, the yield on 10-year Treasury notes has fallen nearly 70 basis points, resulting in the strongly inverted yield curve we observe today. The decline in long-term Treasury rates has been mimicked by a nearly identical fall in conventional mortgage rates over the same period.
Due to strong and liquid corporate balance sheets, risk premiums on corporate debt remain at historically low levels. Since January 2004, the spread between yields on AA-rated debt and the 10-year Treasury rate have varied little, averaging slightly over one basis point. However, risk premiums on lower-rated corporate debt have been higher and more volatile over that period.
Home mortgage debt continued to rise at double-digit rates in the third quarter of 2006, albeit at more modest rates than those observed earlier in the year. Nonrevolving consumer credit growth continued to slow. Much of this slowdown is attributed to a decline in vehicle sales. Monthly data demonstrate a marked slowdown in consumer credit outstanding during October. Nonetheless, levels of consumer debt remain at historically high levels. However, despite high levels of consumer debt, delinquency rates on consumer loans remain subdued.
The Conference Board's Index of Consumer Confidence rose markedly in December, after falling modestly in October and November. December's increase placed the index at its highest level since April. Both the present conditions and expectations component of the index registered increases. Consumer perceptions of conditions in the labor market improved, according to the survey.
In contrast, the University of Michigan Consumer Sentiment Index fell slightly in December. After reaching its highest level since July 2005 in the October survey, the index has fallen modestly during the last two months. The expectations component of the index fell two points from November to December. However, the current conditions component of the index actually rose in December. Lower gasoline prices appear to be an important factor improving consumers' views about their current conditions. According to the Michigan survey, household inflation expectations fell slightly in December, with the one-year ahead inflation expectation at 2.9 percent.