Difference Between Long-Term & Short-Term Rates
When short-term rates are 1.3% to 2% below long-term rates, the difference is positive, and investors expect normal economic growth (2-3 percent per year). When the spread is greater, they expect even faster growth because the Central Bank is likely pushing rates down. This reduces the cost of borrowing for companies so they can expand capital investment. When short-term rates are higher than long-term rates, Central Banks are probably trying to curb inflation. Economic conditions are expected to deteriorate. When short-term rates exceed long-term rates by 1.5% or more, there is a 70% chance the economy will go into recession within the next 12-months. The foregoing can serve as an investment guide. If short-term rates are higher than long-term rates, tighten stops or take other protective measures. If they are 1% or more higher, consider moving to cash (the short-term curve was this far above the long-term curve in 2000 and a 3-year bear market began in that year). When short-term rates are less than 1% below long-term rates, stable growth stocks are attractive. When short-term rates are 1% to 3% less than long-term rates, stocks are even more attractive (a stock-picker’s market). If the spread is more than 3%, invest with the premise that inflation could start to heat up soon.