The majority of the articles on the economy and the markets that I read mention these benchmarks.
Now I think that because these investments are seen as low risk, a demand in appetite for these investments, which I believe lowers the yield, indicates that investors are risk averse and thus uncertain about the economic outlook.

But somehow this explanation leaves me unsatisfied, if I am right in the first place with my assesment.

I also read that lower yield on treasury notes means lower rates on mortgages. If correct, could someone please explain this to me.

well since treasuries are risk free in terms of default, no other investment can have a lower yield, so it sets a floor for other rates, wich would yield the risk free rate of treasuries + a default premium.
there is a market rate of intrest wich is what would come about under the equilibrium of the supply and demand for money in a free market.

since money is controlled centrally via the fed, the rate of intrest is artificially low for political reasons, thus creating boom (housing bubbles, etc) and bust cycles.

Say I can loan between two people. #1 has a stellar credit rating and #2 has a somewhat iffy rating. Obviously at the same interest rate, I would loan to #1 every time. What would it take for me to loan to #2? A higher interest rate. So if the interest rate that I was willing to loan to #1 at was 5%, I wouldn't loan to #2 unless it was maybe 6%. Now suppose, the best interest rate I can get from #1 is 2%. I might be willing to loan to #2 for 3% instead.

#1 = US Government
#2 = Mortgage to Joe Smith

That's the basic explanation at least.

Thanks for the explanations, it is clearer now.

Rates for longer term bonds can also be used as a barometer for market sentiment about the future of the economy. You might have heard of an "inverted yield curve." The yield curve is a line graph of rates by borrowing period. When longer period rates are lower than current and short term rates, it implies a belief that the economy will slow in future years.

I`ve read that a recession is usually preceded by an inverted yield curve, but have a difficulty understanding the fact that longer dated treasuries have a lower yield in realtion to those with a shorter maturation date. It just seems so counterintuitive.

Could you explain this to me?

sorry for the bump Art.

This is just a not-so-yet-maybe-rough recollection from a macroecon class I took last year. Coincidentally, we studied monetary policy and covered the mid-90s Estralla and Mishkin paper shortly before the NBER declared a recession. You can probably pick up Estralla and Mishkin off of the NY Fed's website.

The yield curve doesn't have to be inverted. The yield curve can be flat iirc.
Fed monetary policy indirectly influences business activity through commercial banks ability to lend - investment or loans used to invest in production (factories, equipment, etc). Contractionary monetary policy leads to an increase in short-term interest rates. Long term rates are reliant upon expected future short-term rates. Long term rates do respond to increases (and decreases for that matter) in short-term rates but not to the same magnitude and not as fast - iirc.

When the yield on the 3-month meets up or surpass the 10-year yield, long term investment and short-term spending suffers. The effects may not be felt right away as the reaction time of a business is a lagging economic indicator (much like unemployment). That's why this type of economic model predicts recessions up to 6 quarters in advance. IIRC, it's also not the be-all end-all of economic models and it's results are usually strengthened when used in conjunction with other models. I also recall that this particular model produced a false positive in the 40s or 50s.

HTH.

Just saw the bump, thanks for the answer.

Believe it or not, this is a really deep question. The very short answer is that under ordinary circumstances, the curve is upward sloping. An inverted yield curve signals some sort of inflection/upheaval, such as but not limited to a recession. That much can be agreed on, as to why or how much the curve slopes at any time? You will find lots of competing explanations. Many of them may be correct but it's often a matter of degree as to how much they matter. Just a note/caveat for any further research you do...

Back to your original question, as others noted these are just benchmarks for the "risk free" rate. There is nothing magical about using 3m instead of 6m for short term, or 10y instead of 30y for long term, those are somewhat arbitrary/historical choices. For example, the 30y used to be more commonly used as a long term benchmark, but for a few years (roughly 2001 to 2006), the U.S. stopped issuing the 30y bond, so the 10y became more popular as a benchmark.

Could you please be so kind to point me to a few.
I know google is my friend, but I thought if you had some articles you consider relevant it would be nice to hear.

Sure. Here's a good link.

http://www.pimco.com/LeftNav/Bond+Ba...rve_Basics.htm

In particular, I was referring to the stuff in the middle regarding pure expectations, liquidity preference, and preferred habitat theories.

Good thread, helping me learn here. Question though:

According to your link spider

http://www.pimco.com/LeftNav/Bond+Ba...rve_Basics.htm

The yield curve is more likely to be "normal" than inverted. If this were the case could a trader just always be short the 3 month and always long the 10 year, rolling both over or whatever, for a profit? I assume not but I'd like to know where my reasoning went wrong

I just recently started following macroeconomics so I'm not aware of too many past trends. This thread sparked my interest in the yield curve, so I did some googling and found an interesting article from 2006 discussing the then slightly inverted yield curve.

http://www.econbrowser.com/archives/...eld_curve.html

Wright goes on to show that a higher fed funds rate will lead to a higher probability of a recession. Was this a common view from most economists and why the recession surprised many?

Thanks for the links

Well, not being a bond guy or financial engineer, etc. I'm not sure how to exactly answer. I'll point out though that this is basically what banks do (borrow short lend long) and there is some money to be made on the spread. The problem you may have noticed is that on occasion banks have liquidity issues which is basically the problem inherent in this trade.

But unlike you, they can borrow from the fed if they need to.