Long-term perspective

The spread between long and short interest rates tends to widen near economic downturns and narrows during recovery/expansion. The spread narrowed in 1998 and 1999. In 2000, the yield curve inverted. That is, 10-year note yields were lower than 2-year note yields. Often this behavior signals an economic slowdown. The spread fell over the late 2003 through 2006 period and it appears to have been related to a rise in near-term credit demand and a rise in near-term inflation expectations while longer-term inflation expectations held steady. In early 2007, inflation expectations eased as did credit demand.

Short-term perspective

The spread between 2-year and 10-year note yields flipped back to positive territory in June and has been steadily rising through November as yields on the 2-year note have been dropping faster than that for the 10-year note. Flight to quality has been stronger to the shorter-term note and also the lower yields also reflect expectations of further interest rate cuts by the Fed in 2008. The average yield on 10-year notes fell 38 basis points to 4.15 percent in November and the 2-year note decreased 63 basis points to 3.34 percent.