What will happen to yield curve when economy gets depressed and deflation is recognized as the main driving force?
Peter Oberois
Feb. 10, 2007

As deflation takes hold of the economy, it will eventually get depressed. The initial ecstasy (happening now) in the gold market will end and reality and scare will hit the Wall Street. By end of 2009, it will be well recognized that a new era has started. The food and energy will be in hyperinflation mode and the rest of the economy especially the wages and salaries (cost of labor) will be in deep deflation.

The biggest question is what will happen to the yield curve? The way Central Banks try to tackle the deflation in the economy is by inject excessive liquidity. One such measure that will be employed is the lowering of short-term rates to zero like in Japan today. The long terms rates actually falls faster in normal cases. This time it will be different though. The Asian Banks will start selling their notes and bonds. The long-term rates will sky rocket well above ten percent while the short-term rates will hover below 1%.

The yield curve not only get back to normal, it will actually become very steep with low short-term rates and very high long-term rates. The market expectation will be high inflation thirty years later while deflation in the near future.

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