Mishkin earlier told the audience that the current yield curve inversion "is not signalling a recession."

     "When you look at the yield curve it does have potential information," he said, but one needs to remove the unusually low "term premium" and then compare long-and short-term rates. That comparison "does not tell you there is a recession."

From Q&A session, as reported by Market News 

"I don't think there's a strong message {in the inverted yield curve} for the Federal Reserve or economic policy makers," Kohn said. "It's something we pay attention to" but the bond market "is not sending a traditional signal," he said, explaining that yields can be understood as resulting from strong demand for long term assets and confidence among market participants the conomy will do well and inflation will not be a problem.

And there are other signs beyond housing that may be flashing yellow on growth vulnerability. Certainly, many have focused on what long-term Treasury yields of 50 basis points below the overnight federal funds rate might be telling us about the probability of a downturn. There are several possible alternative explanations for this phenomenon, but it does raise one's antennae.

The shape of the yield curve is not overly convincing in telling us the economy will soften.

From audience Q&A session.

The Federal Reserve could “sit back” and let the bond market play the role of automatic stabiliser in the economy, even amid concern over the housing slowdown, Bill Poole, president of the St Louis Fed, has told the Financial Times...

“The decline in long rates is working as a built-in stabiliser for the economy,” he said, noting that the fall in bond market rates “will tend to bring down mortgage rates” as well...

"The FOMC can some of the time -- maybe even much of the time -- sit back and do relatively little, relying on the stabilising effect of market reactions to current data," he said.  "We don't have to do it all." 

Most of the market commentary, I think, is picking up half the story. The commentary is that the economy is perhaps soft and that the next Fed moves will be down on the Fed funds rate rather than up. So the market is anticipating some easing of monetary policy in the future. That's part of the story.

There's another part of the story, though, which is that the bond market works as a built-in stabilizer for the economy.  So the fact that rates are down is going to tend to support housing, for example, which is very, very sensitive, and other consumer durables, interest-sensitive spending.

So the bond market is serving as a built-in stabilizer and will help to keep the economy from weakening dramatically going forward. That's my expectation.

Interest-rate expectations reflect investor understanding of how rates will evolve, which is why an inverted yield curve has often preceded business cycle peaks. But the market’s rate expectations also depend importantly on the market’s read of what the FOMC will do. If the market’s expectation does not match the FOMC’s own expectation, then policymakers need to do some soul searching.

Although macroeconomic forecasting is fraught with hazards, I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come, for several reasons. First, in previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint. This time, both short- and long-term interest rates--in nominal and real terms--are relatively low by historical standards.

Second, as I have already discussed, to the extent that the flattening or inversion of the yield curve is the result of a smaller term premium, the implications for future economic activity are positive rather than negative.

Finally, the yield curve is only one of the financial indicators that researchers have found useful in predicting swings in economic activity. Other indicators that have had empirical success in the past, including corporate risk spreads, would seem to be consistent with continuing solid economic growth. In that regard, the fact that actual and implied volatilities of most financial prices remain subdued suggests that market participants do not harbor significant reservations about the economic outlook.

Historically, flat or inverted yield curves owing to unusually high short-term rates have tended to be followed by slowdowns, but that has not been the case for those episodes of inverted yield curves owing to relatively low long-term rates. And, in the current situation, the flatness of the term structure results largely from relatively low long-term yields.

In the past, when the inverted yield curve presaged a slowdown in the economy, it was usually in a situation where both long-term and short-term interest rates were actually quite high in real terms, suggesting a good bit of drag on the economy.  Currently, the short-term real interest rate is close to its average level and the long-term real interest rate is actually relatively low compared to historical norms.  And so with real interest rate not creating a drag on economic activity, I don't anticipate that the term structure is signal of oncoming slowing of the economy.

Thus, concerns that a flat yield curve could spell economic doom are "somewhat overblown."

"What we have in the yield curve inversion...is correlation without causality," Lacker explained.

"Some of the discussion reminds me of medieval times when the arrival of a comet would spark a sort of apocalyptic hysteria," he said.

From a Dow Jones Newswire report on comments to reporters after his speech.

Although the slope of the yield curve remains an important financial indicator, it needs to be interpreted carefully.  In particular, a flattening of the yield curve is not a foolproof indicator of future economic weakness.  For example, the yield curve narrowed sharply over the period 1992-1994 even as the economy was entering the longest sustained expansion of the postwar period.

A sharp flattening of the yield curve is not a foolproof indicator of economic weakness.  Indeed, the yield curve narrowed sharply over the period 1992-1994 even as the economy was entering the longest sustained expansion of the postwar period.

I do not believe an inverted yield curve will be a sure-fire indicator [of an upcoming economic downturn].