Green Shoots? Sorry, No

The talk of economic “green shoots” attracts media coverage – and naturally since it is a departure from the narrative or expectation that defines news.  But is the lamented economy’s current state, variably compared to a number of seismic economic events, really entering its blooming spring?  Or is the pace of the slowdown merely easing?  The search for economic correlations and relevant historical precedents has taken flight.

The problem with economic correlations and historical references, of course, is that they do not always hold when situations change.  Take the theory that an inversion of the yield curve – when short-term interest rates are higher than long-term rates – precedes economic slowdown.  What if the history of the yield curve correlation is confounded by the simple fact that higher short rates, the ones most likely to coincide with an inversion, exist when the Federal Reserve is tightening?  The current gap between low short-term nominal rates (near zero) and 10-yr Treasury securities (around 3.17% Tuesday) is seen, in some circles, as a sign that the economy is positioned to recover.

Some important developments in the bond market and on interest rates impact the Obama Administration’s forward-looking economic view, which is to say the rosier view conveyed in the budget and not the doomsday Great Depression howling that was more expedient in the fall (and then truer).

Christina Romer, chairwoman of the White House Council of Economic Advisers, recently said that “business investment” would likely lead the recovery.  (Indeed, U.S. consumption is not likely to regain its former momentum as home prices, and retirement portfolio hemorrhaging will increase the savings rate, lowering consumption).

Business investment, obviously, is sensitive to interest rates.  And when the government issues trillions of dollars in U.S. Treasury securities, prices go down, and yields go up.  The Federal Reserve can temper the upward pressure on long-term yields by buying 10-yr government bonds; the Fed famously declared in March its intention to buy $300 billion in long-term bonds, an unprecedented step.

The question becomes whether the Fed, with some help from China, can keep demand high enough to offset the supply glut coming out of the federal government’s financing needs.  The Fed has taken extraordinary measures to keep enough liquidity in the system to avoid deflation (a threat more immediate than inflation).  But buying bonds at the right time and in the right amount will be critical to keeping long-term interest rates low.

Punxsutawney Phil might fear that these first buds of spring need to be delayed a lot more than six weeks – unless, of course, the federal government did not need to sell so many Treasury securities in the first place.