Despite weaknesses, yield curve offers opportunity

Although the economy is improving, there are still considerable indications that the recovery may be only short-lived. That was the conclusion presented by Jim Nowak and Ben Eskierka, both from United Bankers' Bank of Bloomington, Minn. The two presented at the bank's annual spring conference, conducted April 9 at the Embassy Suites Hotel in Bloomington.."We need the housing market and the consumer to start to participate or this recovery ends in 2011," Nowak said. Housing inventories are rising now that spring is here, Nowak said. Housing affordability is high and Nowak suggested it will increase as housing prices drop further in response to bank OREO inventories that will hit the market over the coming months..Additional clouds over the economy include gas and oil prices, which are at 18-month highs. Furthermore, unemployment remains problematic. Nowak said there are nearly six unemployed people for every existing job opening. Typically, the rate is about three or fewer people looking for every job open. The core economy, which does not include government jobs, continues to shed jobs, he noted..While the economy is working through its problems, the yield curve offers bankers an opportunity to strengthen their earnings. "We have an extremely steep yield curve and it is steepening," Eskierka said. Noting a difference of some 270 basis points between the yield of a two-year Treasury Bond and a 10-year Treasury Bond, Eskierka said: "The Fed is giving this yield curve to you to help you make money to recapitalize and get out of this mess.".Eskierka said it will be some time before the Fed begins raising rates again. He noted, for example, that historically the Fed has waited at least 12 months after the unemployment rate peaks before raising rates. The unemployment rate was 10.1 percent in October 2009, and currently is at 9.7, suggesting it will be at least October before the Fed raises rates..Furthermore, Eskierka said the low core inflation rate suggests little need to raise rates to combat inflation. Core inflation is the regular inflation rate minus food and energy. That rate is currently about 1.3 percent, a position the Federal Reserve generally likes, Eskierka said. Earlier in the decade, when the rate slipped to nearly 1.0 percent, officials openly worried about disinflation..Eskierka noted that there is so much money available that an increase in the fed funds rate would be ineffective. There is little demand for overnight fed funds, he said..The only tool the Fed has at this point is the ability to raise the rate it pays on reserves held at the Fed. If it raises rates, banks will be inclined to deposit more at the Fed, thus shrinking the availability of credit from banks..The Fed raised the discount rate recently but Eskierka said that increase was an attempt to restore the historic relationship between the discount rate and the fed funds rate. During the height of the financial crisis, the discount rate was lowered to only 25 basis points over the fed funds rate. Typically, 100 basis points has separated the rates. The increase earlier this year puts the difference currently at 50 basis points. "In no way should increases in the discount rate be perceived as an effort to tighten credit," Eskierka said..Eskierka concluded by encouraging bankers to "take advantage of the yield curve." Nowak commented: "I remain guardedly optimistic the recovery can gain momentum this summer." Without the consumer, however, he said, the business cycle and credit cycle will be short-lived.."Either way, the business cycle is set to shorten and we should expect more economic volatility and recessions for quite some time," Nowak said.