WASHINGTON – Whether a harbinger of troubled economic times or a quirk due to light trading around the holidays, this week’s flip in the bond market – where long-term investments for a while fetched lower interest rates than short-term ones – bears close watching. Yields, or the return, on 10-year Treasury notes on Tuesday dropped slightly below the yields on two-year notes, marking the first time this has happened in five years. This phenomenon, also evident for part of the trading session Wednesday, is called an “inverted yield curve” and in the past it has often preceded a recession. Typically longer-term instruments carry higher interest rates than shorter-term ones to compensate investors for tying up their money over a longer time frame – a decision that can be fraught with uncertainty. When the situation reverses, it signals that bond investors are betting that interest rates down the road will move lower, something that can happen in the event the economy were to slow down or slip into a recession, thus blunting any concern about inflation. Analysts pointed out that the difference, or spread, between the two instruments is tiny and it comes during the holidays when lighter than normal trading volume can magnify movements in bond prices. Bond prices and yields move in opposite directions. Against this backdrop, “I think the message in this inverted yield curve is muddled,” said Mark Zandi, chief economist at Moody’s Economy.com. “I think what we are seeing with the bond yields is a byproduct of globalization. That being said, I think it is something to watch and to understand better. But I am not overly concerned.” Zandi and other analysts continue to believe the U.S. economy will remain in good shape. The economy, which grew at a stellar 4.2 percent in 2004, is expected to log solid growth of around 3.6 percent this year and 3.3 percent in 2006, according to some projections. Greenspan and other economists have indicated that given all the forces – especially global ones – that can affect the U.S. financial market – the inverted yield curve might no longer be a useful predictor of future economic activity. “Many factors can affect the slope of the yield curve, and these factors do not all have the same implications for future output growth,” Greenspan wrote in late November in response to a lawmaker’s question about it. Still, economists weren’t willing to completely shrug off Tuesday’s flip. The economy’s last recession, in 2001, was preceded by an inverted yield that started in 2000, analysts said. Inverted yield curves preceded the past six recessions, analysts said. But there were two times, most recently in 1998, when the yield curve inverted but the economy didn’t slip into recession, they noted. If the flip seen Tuesday were to be sustained and the gap between the yields on the two-year and 10-year Treasury notes were to widen, it could spell trouble, analysts said. Credit could get seriously crimped, they said. Banks normally borrow money at short-term rates and lend out the money at longer-term rates. “When the yield curve inverts, banks’ funding costs rise above what they earn by lending. This can produce a credit crunch,” said Greg McBride, senior financial analyst at Bankrate.com. The housing market also could be hurt if the pool of money available for lending were to dry up. Well before Tuesday’s flip, the yield curve was flattening, analysts said. For nearly two years, the Federal Reserve has been boosting short-term interest rates to keep the economy and inflation on an even keel. During that time, however, longer-term interest rates have stayed surprisingly low and the economy has motored ahead. Greenspan once referred to this puzzling divergence in short- and long-term rates as a “conundrum.” The Fed’s key short-term rate, called the federal funds rate, now stands at a 4 year high of 4.25 percent. The funds rate, the interest banks charge each other on overnight loans, directly affects the prime lending rate as well as short-term adjustable-rate mortgages. Another increase in the funds rate is expected Jan. 31, Greenspan’s last meeting as chairman. After that, the reins will be turned over to Ben Bernanke, who will have to deal with any economic challenges that come his way. 160Want local news?Sign up for the Localist and stay informed Something went wrong. Please try again.subscribeCongratulations! You’re all set! AD Quality Auto 360p 720p 1080p Top articles1/5READ MORERose Parade grand marshal Rita Moreno talks New Year’s Day outfit and ‘West Side Story’ remake For now, though, many analysts – while keeping close tabs on the behavior of bonds – are not ready to ring the alarm. A number of other, more positive forces could be helping to keep long-term interest rates unusually low. Economists said the low longer-term rates might reflect investors’ confidence in the Federal Reserve’s inflation-fighting prowess. The hearty appetite of foreign investors for U.S. Treasury securities – viewed as one of the most safe investments in the world – is another factor believed to be behind the low longer-term rates. Increased competition from an ever-growing global marketplace has helped to keep inflation under control and also may explain the low longer-term rates, economists said. On Tuesday the yield on the 10-year Treasury note was 4.34 percent, a tad lower than the two-year note’s yield of 4.35 percent. The yields, which had hovered in that range for part of Wednesday had switched by the close of trading. The 10-year yield stood at 4.37 percent, up a notch from the two-year’s yield of 4.36 percent.