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A quick explanation in layman's terms: I have money on hand and I want to put it into something safe. The US government is constitutionally bound to pay its de

A quick explanation in layman's terms: I have money on hand and I want to put it into something safe. The US government is constitutionally bound to pay its debts, and is generally considered to be very safe (if not the safest investment around). The US government sells bonds with different terms. I can buy 1 year bonds, 3 year bonds, 5 year bonds, 10 year bonds, etc. The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note. Right now, (annualized) rates [1] are approximately as follows: 1 month - 2.30% 6 month - 2.56% 1 year - 2.72% 3 year - 2.84% 5 year - 2.83% 7 year - 2.90% 10 year - 2.98% Notice that the 3 year rates are higher than the 5 year rates. Generally speaking, if I'm going to lock up my money for more time, I expect a higher return. However, today, the 3 year notes are getting a higher rate of return than the 5 year notes. Why? Interest rates generally tend to follow the economy at large. When the economy is doing well, people will invest in stocks and other investments and are less willing to pay for the safety of treasuries, so effective rates go up when people bid less at treasury auctions (additionally, the government will take steps via the Federal Reserve to make rates higher). By the same token, when the economy isn't doing well, people want the safety of treasuries, even if they pay less, so effective rates on treasuries tend to go down. In rare cases, the yield curve will invert. What this means is that investors think that rates of return on government bonds are going to go down in the future. In order to lock in a better rate now, they're willing to pay more for longer term bonds (in this case, 5 year bonds vs. 3 year bonds) in order to "lock-in" the good rates. The assumption is that they won't be able to get the same good rates if they don't act now. Note that only the 3 and 5 years have inverted. If people were really panicked, you would probably see a more significant inversion, where for example, the 1 year was higher than the 2 year and the 2 higher than the 3, etc. [1] these rates are actual rates of return calculated based on the auction price paid

Waterluvian 8y ago
Thanks for this. It really helped. So if we look at the very long term rates, do those signal that we are broadly confident that the US economy will be healthy long term? Or is there no signal there?
- rb808 8y ago
  For long term rates nobody really knows because for the last 10 years central banks have been buying trillions of the stuff. The US Fed has started selling some and long term rates were rising until the Nov stockmarket selloff. No one is sure what is going to happen next. If we go into recession again with no inflation - long term rates are too high. If inflation picks up, current long term rates are way too low. If the government keeps running huge deficits and Fed keeps selling, long term rates could pick up. Unless Europeans and Asians start buying again of course.
- jonbarker 8y ago
  In general, when longer term bonds have higher yields, this is investors saying "compensate me for the opportunity cost of not being in stocks or riskier assets over that term". What matters is that the yield curve goes up as the maturity date goes out in the future, signaling a healthy outlook for risker assets. If the yield curve inverts, this can be interpreted as investors saying "the longer term outlook for riskier assets like stocks is not good, so I don't need compensation for longer term less risky bonds, just get me out of the market." It is a remarkably reliable indicator of future trouble for stocks.
  - babaganoosh89 8y ago
    Not really, short-term interest rates are set by the fed and long-term interest rates are determined by bond investors betting what the avg interest rate will be over that time period. So when the yield curve inverts, investors are betting that the fed will have to cut rates in the future (because of a recession or other reasons), making the long-term interest rates lower than the current short-term rates.
    - sokoloff 8y ago
      I think you might be looking at a different side of the same coin as GP. Betting that the Fed will have to cut rates because of a recession is a bet against equities and other risk assets.
    - 8y ago
NTDF9 8y ago
Great explanation. What about the fact that US treasury is issuing more bonds to fund extremely large deficits? How does that play into the equation you described? Wouldn't so many bonds flood the market with bonds available and thus raise the yield rates on 10-year?
- skybrian 8y ago
  The Treasury Department sells a variety of securities. I wasn't able to find anything about how they choose auction amounts, but it would make sense for them to borrow using whatever kind they can get the best rate on, rather than 10-year bonds in particular. If so, the mix would depend on market demand.
YetAnotherNick 8y ago
I think it's more common in developing nations. I saw this when doing fixed deposit in India and was very surprised. It makes sense as it is expected that the safety of the investment will increase as the country develops and the interest rate is likely to fall, as it is currently three times as that of US.
haidut 8y ago
OK, I have a (probably stupid) question. If the 3-month T-bond rate is say 2.32%, does that mean that I can buy such a 3-month security 4 times in a row in a given year to get a total of 4 * 2.32 = 9.28% ROI on the money I am using to invest? Actually, the return would technically be higher than since the second, third and fourth times I am buying the T-bond I will use not only the original cash I had on hand but also the 2.32% return I received each time I bought the T-bond. So, assuming everything is re-invested in the 3-month T-bond the total ROI for a given year would be about 9.6% (assuming the rates stay the same of course). A ROI of 9.6% is quite good and beats stock market return over most years, while also being virtually risk-free. Am I missing something here? Why invest in a (risky) stock market unless you can reasonably expect a return in the double digits that can compensate for the extra risk, compared to a 9.6% risk-free ROI from T-bonds? Please pardon my ignorance and thanks in advance.
- ttul 8y ago
  Nah, those are annualized figures. Buying a three months four times will give you ~2.32.
  - haidut 8y ago
    OK, thanks. Then what would buying a 3-month one once a year give me? Still 2.32%, or 2.32% / 4? Also, since right now the 3-year bond offers more than a 5-year one, why would anyone prefer to buy the 5-year bond? Doesn't the 3-year one offer the same (or better) return over a shorter period of time?
    - cm2187 8y ago
      2.32% / 4. Technically the "/4" may not be exactly "/4" depending on the bond. It is called day count fraction and for some bonds the rules can be quite complex. But the basic idea is to prorate ("accrue") the interest rate to the time you held the bond.
    - zaroth 8y ago
      2.32% / 4. And hopefully that answers your second question as well. The rate is annualized, meaning the profit if you held the bond for 1 year. So a 3 year bond at 2.32% pays a 2.32% annual interest rate. Interest payments are made twice a year. A 5 year bond at 2.32% pays the same rate of return — 2.32% interest per year, but in that case guaranteed to continue paying at the same rate for 5 years instead of 3. The rate is the annual rate. The term is for how long interest payments are made and how long until the bond “matures” — when the face value is paid back. If people think rates are going to go down in the future, then they will accept a slightly lower rate if it is locked in for a longer term, which is the idea behind the “inversion”.
beginningguava 8y ago
As far as insight for how this looks for the US economy, one of the few people I respect when it comes to predictions is Ray Dalio, he says the US debt will start becoming an issue soon. Within 10 years the majority of the US federal budget will go to paying INTEREST on our debt, requiring us to borrow more to pay for the rest which will result in exponentially rising debt and inflation as the government prints money. Dalio also talks about Thucydides Trap and Paul Kennedy's book on the decline of great powers. He doesn't say it but he seems fairly confident in China surpassing the US as the dominant global power in the near future. The only issue I have is that he seems to think China's high debt is fine compared to the US based on vague reasoning. The US and the West in general need to wake the fuck up or we're going to be under China's thumb. We've become complacent and assume our status on top of the global hierarchy is guaranteed. China is playing to win and doesn't care about breaking the rules to win
- smsm42 8y ago
  > he says the US debt will start becoming an issue soon Which makes sense, but - I've been hearing this for couple of decades, and it doesn't seem to happen. I am not sure I understand why it doesn't happen and why people seem to care about the mountain of US debt much less than I think they should - but this looks like what is happening for a while. I still think this will become an issue sometime in the future, but I have no idea how one can predict how soon it would be. > he seems fairly confident in China surpassing the US as the dominant global power in the near future That depends a lot of what you mean by "dominant" and "near future", I guess. If you pick your criteria well enough, you could both claim China is already dominant (I mean, look at where all the stuff is manufactured! And their population numbers! And their GDP growth!) or that they are hopelessly behind (I mean, look at their GDP per capita - it's on part with Iraq! Nobody thinks Iraq is dominant... Or look at the immigration patterns - are a lot of people from other developed countries dream to go to China, or vice versa? How dominant can be the country where their own population rather live somewhere else?) So you could make either claim without too much effort.
  - stephen_g 8y ago
    Modern monetary theory is the only one that can adequately explain why it's not a problem in my opinion. The kind of people who say that the US's debt is totally going to be a problem any year now have generally being saying that for years, as well as saying that about Japan's since the early 90's. But MMT proposes that a monetarily sovereign currency issuer (like the US, UK, Japan, Australia, New Zealand, etc. but not Euro-using countries, or anybody with a gold standard, fixed exchange rates etc.) actually have the ability to service any debt denominated in their own currencies, and analysis to pretty confidently say that it would not be inflationary to just pay them out (i.e by money creation). The inflation risk was at the time when the spending of the bond money happened, so paying them out with new money is asset neutral - the only difference is it just gives the bond-holder a more liquid asset. Then there are other useful tools like sectoral balances, etc. that help explain the links between one of the things that really matters (private debt) and how it relates to Government spending and trade surplus/deficit. A few of the twelve or so people who accurately described the great recession a few years before it happened used this method at the core (e.g. Keen, Godley). It flies pretty hard in the face of conventional economic wisdom, but I haven't yet found an economic theory that holds up so strongly to real world observation, i.e. in explaining why Greece has huge debt problems but not Germany (Eurozone, but trade surplus) or the US (monetarily sovereign), and why Venezuela and Zimbwabe have their problems (debt denominated in foreign currencies, supply shocks, etc.) vs. Japan (monetarily sovereign) while they seem to do similar things, etc.
StanislavPetrov 8y ago
>The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note. Its important to point out that these are not market-based auctions. The Federal Reserve regularly steps in to purchase its own bonds (in effect skewing the price of the auction). The FED currently holds ~4 trillion worth of bonds purchased in prior auctions (its not currently increasing its holdings but it is repurchasing). https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm https://www.federalreserve.gov/monetarypolicy/bst_recenttren... Central bank purchasing their own bonds can act to prop up the market, but also to disrupt market forces by keeping a "thumb on the scale". While this was initially done as an attempt to stimulate the markets after the crash of 2007/2008, it was never ceased, putting the whole financial system into real jeopardy when there is another crash and central banks have used up all of their bullets. This is a financial experiment with an uncertain end. The balance sheet of the BOJ as recently passed its annual GDP. https://www.reuters.com/article/us-japan-economy-boj/bank-of-japans-balance-sheet-now-larger-than-countrys-gdp-idUSKCN1NI07Z https://www.reuters.com/article/us-japan-economy-boj/bank-of...
- gbumakefan 8y ago
  And, as unpopular as bitcoin is, the above description of actions taken following 2008 is why bitcoin was invented.
- neuromancer2701 8y ago
  The FED has been unwinding the balance sheet this whole year. Granted the rate started out at 16 Billion/month and was capped at 40B/month. So there have been plenty of jokes about how it will take years to unwind 4 Trillion. I think we have just passed 150 Billion there is a pretty cool chart out there somewhere. The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP.
  - StanislavPetrov 8y ago
    >The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP. One of many concerns! Given that the solvency of the USA and the entire global economy is predicated on interest rates not rising substantially, things are going to get very interesting (not in a good way) next time we have an economic crisis.
tanilama 8y ago
Does it also mean that the money in short term will get more expensive?
coffeemug 8y ago
How well does the U.S. yield curve perform as a prediction market for S&P 500 prices? Is there a strong correlation between what investors expect will happen in 3-5 years (ie the yield curve), and what actually happens?
- odonnellryan 8y ago
  I think it's so hard to tie these together, because there are a lot of motivators that can lead to the yield curve inverting, also there are different yield curves that can invert. Currently talk is that the 5/30 is what we should look at, traditionally it is the 2/10, the one everyone is talking about now is the 3/5... and just one bps for the 3/5... and actually when people talk about the indicator they really mean for a quarter... well, some do. Sometimes people say a month. Or... some other amount of time. Basically it's a lot of noise. It doesn't mean nothing, but...
  - pydeveloper22 8y ago
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porpoisely 8y ago
Nice write up. But I want to point out that interest rates are leading indicators of the economy, it doesn't follow the economy. It's why the inverted yield curve is one of the widely looked at indicators for future economic health. So the yield curve inversion isn't saying the economy right now isn't doing well. What it is saying is that the market ( or a large percentage of institutional investors ) think the economy won't do well in the future. As you noted, it's only a slight inversion of only the 3 and 5 year, so it isn't that alarming for the moment. Just as important as the yield curve is what the FED is going to do with interest rates. If they consistently raise it every quarter for the foreseeable future, then the odds of a recession will increase considerably.
- deleted 8y ago
  [deleted]
nodesocket 8y ago
Capital One is offering money market savings accounts earning 2.0%, with no caps, and no time limits. Sure, I could buy a 1 year bond, and earn the extra .72%, but I rather have the flexibility to withdraw at anytime with the Capital One money market account.
panarky 8y ago
Shorter summary - historically, yield curve inversions have been pretty reliable predictors of recession. There are no certainties, of course, but the probability is pretty high that in the next 6 to 24 months we'll see negative economic growth and increasing unemployment.
rafkin98 8y ago
The classic recession signal that most follow is a 2-10 inversion.
dskhatri 8y ago
[1] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield https://www.treasury.gov/resource-center/data-chart-center/i...
75dvtwin 8y ago
@chadash thx for the explanation. With regards to > that investors think that rates of return on government bonds are going to go down in the future. Does it mean that investors think that US government will pay 'less interest' in the future for these 5 year bonds ? If yes, does that mean that investors think that US government will be willing to pay less to its lendors (the bond holders). Which, would also mean that bond buyers think it is good time now to lock in a higher rate. (seems like a good thing if one is a US taxpayer, if the gov will pay less to money lenders, unless US people are starving...). For example, Ukrain's 3 year bond pays 18% http://www.worldgovernmentbonds.com/bond-historical-data/ukraine/3-years/ http://www.worldgovernmentbonds.com/bond-historical-data/ukr...
- chadash 8y ago
  I didn't want to get too much into the weeds, but it's actually the market [1] that determines the rates. What the US wishes to pay is irrelevant. As stated in my original post, the treasury sets an interest rate and a face value on its bonds. Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more). So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields. [1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now. [2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example. [3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).
gota 8y ago
Great write up. Also in layman's terms: what do investors generally do when gearing up towards a recession, other than buy long-term (and low-yield) bonds in advance?
c3534l 8y ago
> The US government is constitutionally bound to pay its debts Since when? Please point me to the part of the constitution that says that.
- shaki-dora 8y ago
  Since 17someting: Article VI > All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution. It requires a minimum of good faith, which you possibly lack. But it clearly implies that debt exists, and that it can be valid. The fact that valid debt is to be repaid is not clearly spelled out in the constitution, because the founding fathers did not believe there would ever be a time where idiot vandals trashed about requiring every minute detail to be proven from first principle.
  - c3534l 8y ago
    That doesn't mean the government can't default on its debts, it means that the new government would assume the debts of its predecessor. Context from Wikipedia: > The states and the Confederation Congress both incurred large debts during the Revolutionary War, and how to repay those debts became a major issue of debate following the War. Some States paid off their war debts and others did not. Federal assumption of the states' war debts became a major issue in the deliberations of the Constitutional Convention. As for the rest of your comments, I used to like it when HackerNews was somewhat civil.
  - dragonwriter 8y ago
    Art. VI only says that the US under the Constitution chose to assume the debts of the US under the AoC. What seems closer to what you want is the first part of Section 4 of the 14th Amendment: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” (Which still, strictly, doesn't say the debt will be paid, only that it's validity will not be questioned.)
- chadash 8y ago
deleted 8y ago
[deleted]

Waterluvian 8y ago

Thanks for this. It really helped. So if we look at the very long term rates, do those signal that we are broadly confident that the US economy will be healthy long term? Or is there no signal there?

rb808 8y ago
For long term rates nobody really knows because for the last 10 years central banks have been buying trillions of the stuff. The US Fed has started selling some and long term rates were rising until the Nov stockmarket selloff. No one is sure what is going to happen next. If we go into recession again with no inflation - long term rates are too high. If inflation picks up, current long term rates are way too low. If the government keeps running huge deficits and Fed keeps selling, long term rates could pick up. Unless Europeans and Asians start buying again of course.
jonbarker 8y ago
In general, when longer term bonds have higher yields, this is investors saying "compensate me for the opportunity cost of not being in stocks or riskier assets over that term". What matters is that the yield curve goes up as the maturity date goes out in the future, signaling a healthy outlook for risker assets. If the yield curve inverts, this can be interpreted as investors saying "the longer term outlook for riskier assets like stocks is not good, so I don't need compensation for longer term less risky bonds, just get me out of the market." It is a remarkably reliable indicator of future trouble for stocks.
- babaganoosh89 8y ago
  Not really, short-term interest rates are set by the fed and long-term interest rates are determined by bond investors betting what the avg interest rate will be over that time period. So when the yield curve inverts, investors are betting that the fed will have to cut rates in the future (because of a recession or other reasons), making the long-term interest rates lower than the current short-term rates.
  - sokoloff 8y ago
    I think you might be looking at a different side of the same coin as GP. Betting that the Fed will have to cut rates because of a recession is a bet against equities and other risk assets.
  - 8y ago

NTDF9 8y ago

Great explanation. What about the fact that US treasury is issuing more bonds to fund extremely large deficits? How does that play into the equation you described? Wouldn't so many bonds flood the market with bonds available and thus raise the yield rates on 10-year?

skybrian 8y ago
The Treasury Department sells a variety of securities. I wasn't able to find anything about how they choose auction amounts, but it would make sense for them to borrow using whatever kind they can get the best rate on, rather than 10-year bonds in particular. If so, the mix would depend on market demand.

YetAnotherNick 8y ago

I think it's more common in developing nations. I saw this when doing fixed deposit in India and was very surprised. It makes sense as it is expected that the safety of the investment will increase as the country develops and the interest rate is likely to fall, as it is currently three times as that of US.

haidut 8y ago

OK, I have a (probably stupid) question. If the 3-month T-bond rate is say 2.32%, does that mean that I can buy such a 3-month security 4 times in a row in a given year to get a total of 4 * 2.32 = 9.28% ROI on the money I am using to invest? Actually, the return would technically be higher than since the second, third and fourth times I am buying the T-bond I will use not only the original cash I had on hand but also the 2.32% return I received each time I bought the T-bond. So, assuming everything is re-invested in the 3-month T-bond the total ROI for a given year would be about 9.6% (assuming the rates stay the same of course). A ROI of 9.6% is quite good and beats stock market return over most years, while also being virtually risk-free. Am I missing something here? Why invest in a (risky) stock market unless you can reasonably expect a return in the double digits that can compensate for the extra risk, compared to a 9.6% risk-free ROI from T-bonds? Please pardon my ignorance and thanks in advance.

ttul 8y ago
Nah, those are annualized figures. Buying a three months four times will give you ~2.32.
- haidut 8y ago
  OK, thanks. Then what would buying a 3-month one once a year give me? Still 2.32%, or 2.32% / 4? Also, since right now the 3-year bond offers more than a 5-year one, why would anyone prefer to buy the 5-year bond? Doesn't the 3-year one offer the same (or better) return over a shorter period of time?
  - cm2187 8y ago
    2.32% / 4. Technically the "/4" may not be exactly "/4" depending on the bond. It is called day count fraction and for some bonds the rules can be quite complex. But the basic idea is to prorate ("accrue") the interest rate to the time you held the bond.
  - zaroth 8y ago
    2.32% / 4. And hopefully that answers your second question as well. The rate is annualized, meaning the profit if you held the bond for 1 year. So a 3 year bond at 2.32% pays a 2.32% annual interest rate. Interest payments are made twice a year. A 5 year bond at 2.32% pays the same rate of return — 2.32% interest per year, but in that case guaranteed to continue paying at the same rate for 5 years instead of 3. The rate is the annual rate. The term is for how long interest payments are made and how long until the bond “matures” — when the face value is paid back. If people think rates are going to go down in the future, then they will accept a slightly lower rate if it is locked in for a longer term, which is the idea behind the “inversion”.

beginningguava 8y ago

As far as insight for how this looks for the US economy, one of the few people I respect when it comes to predictions is Ray Dalio, he says the US debt will start becoming an issue soon. Within 10 years the majority of the US federal budget will go to paying INTEREST on our debt, requiring us to borrow more to pay for the rest which will result in exponentially rising debt and inflation as the government prints money. Dalio also talks about Thucydides Trap and Paul Kennedy's book on the decline of great powers. He doesn't say it but he seems fairly confident in China surpassing the US as the dominant global power in the near future. The only issue I have is that he seems to think China's high debt is fine compared to the US based on vague reasoning. The US and the West in general need to wake the fuck up or we're going to be under China's thumb. We've become complacent and assume our status on top of the global hierarchy is guaranteed. China is playing to win and doesn't care about breaking the rules to win

smsm42 8y ago
> he says the US debt will start becoming an issue soon Which makes sense, but - I've been hearing this for couple of decades, and it doesn't seem to happen. I am not sure I understand why it doesn't happen and why people seem to care about the mountain of US debt much less than I think they should - but this looks like what is happening for a while. I still think this will become an issue sometime in the future, but I have no idea how one can predict how soon it would be. > he seems fairly confident in China surpassing the US as the dominant global power in the near future That depends a lot of what you mean by "dominant" and "near future", I guess. If you pick your criteria well enough, you could both claim China is already dominant (I mean, look at where all the stuff is manufactured! And their population numbers! And their GDP growth!) or that they are hopelessly behind (I mean, look at their GDP per capita - it's on part with Iraq! Nobody thinks Iraq is dominant... Or look at the immigration patterns - are a lot of people from other developed countries dream to go to China, or vice versa? How dominant can be the country where their own population rather live somewhere else?) So you could make either claim without too much effort.
- stephen_g 8y ago
  Modern monetary theory is the only one that can adequately explain why it's not a problem in my opinion. The kind of people who say that the US's debt is totally going to be a problem any year now have generally being saying that for years, as well as saying that about Japan's since the early 90's. But MMT proposes that a monetarily sovereign currency issuer (like the US, UK, Japan, Australia, New Zealand, etc. but not Euro-using countries, or anybody with a gold standard, fixed exchange rates etc.) actually have the ability to service any debt denominated in their own currencies, and analysis to pretty confidently say that it would not be inflationary to just pay them out (i.e by money creation). The inflation risk was at the time when the spending of the bond money happened, so paying them out with new money is asset neutral - the only difference is it just gives the bond-holder a more liquid asset. Then there are other useful tools like sectoral balances, etc. that help explain the links between one of the things that really matters (private debt) and how it relates to Government spending and trade surplus/deficit. A few of the twelve or so people who accurately described the great recession a few years before it happened used this method at the core (e.g. Keen, Godley). It flies pretty hard in the face of conventional economic wisdom, but I haven't yet found an economic theory that holds up so strongly to real world observation, i.e. in explaining why Greece has huge debt problems but not Germany (Eurozone, but trade surplus) or the US (monetarily sovereign), and why Venezuela and Zimbwabe have their problems (debt denominated in foreign currencies, supply shocks, etc.) vs. Japan (monetarily sovereign) while they seem to do similar things, etc.

StanislavPetrov 8y ago

>The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note. Its important to point out that these are not market-based auctions. The Federal Reserve regularly steps in to purchase its own bonds (in effect skewing the price of the auction). The FED currently holds ~4 trillion worth of bonds purchased in prior auctions (its not currently increasing its holdings but it is repurchasing). https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm https://www.federalreserve.gov/monetarypolicy/bst_recenttren... Central bank purchasing their own bonds can act to prop up the market, but also to disrupt market forces by keeping a "thumb on the scale". While this was initially done as an attempt to stimulate the markets after the crash of 2007/2008, it was never ceased, putting the whole financial system into real jeopardy when there is another crash and central banks have used up all of their bullets. This is a financial experiment with an uncertain end. The balance sheet of the BOJ as recently passed its annual GDP. https://www.reuters.com/article/us-japan-economy-boj/bank-of-japans-balance-sheet-now-larger-than-countrys-gdp-idUSKCN1NI07Z https://www.reuters.com/article/us-japan-economy-boj/bank-of...

gbumakefan 8y ago
And, as unpopular as bitcoin is, the above description of actions taken following 2008 is why bitcoin was invented.
neuromancer2701 8y ago
The FED has been unwinding the balance sheet this whole year. Granted the rate started out at 16 Billion/month and was capped at 40B/month. So there have been plenty of jokes about how it will take years to unwind 4 Trillion. I think we have just passed 150 Billion there is a pretty cool chart out there somewhere. The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP.
- StanislavPetrov 8y ago
  >The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP. One of many concerns! Given that the solvency of the USA and the entire global economy is predicated on interest rates not rising substantially, things are going to get very interesting (not in a good way) next time we have an economic crisis.

tanilama 8y ago

Does it also mean that the money in short term will get more expensive?

coffeemug 8y ago

How well does the U.S. yield curve perform as a prediction market for S&P 500 prices? Is there a strong correlation between what investors expect will happen in 3-5 years (ie the yield curve), and what actually happens?

odonnellryan 8y ago
I think it's so hard to tie these together, because there are a lot of motivators that can lead to the yield curve inverting, also there are different yield curves that can invert. Currently talk is that the 5/30 is what we should look at, traditionally it is the 2/10, the one everyone is talking about now is the 3/5... and just one bps for the 3/5... and actually when people talk about the indicator they really mean for a quarter... well, some do. Sometimes people say a month. Or... some other amount of time. Basically it's a lot of noise. It doesn't mean nothing, but...
- pydeveloper22 8y ago
  Hi odonnellryan, My apologies in advance that this may not be the response you were looking forward to on forum question. But I discovered an older post online on the Hacker News site some time ago for a Remote Junior Programmer/Assistant at Luma. I noticed you were looking to make your first hire and find someone that has some knowledge in technologies such as Python and Linux. Well, I had completely forgot about viewing it and so I was checking out Hacker News job board today and saw it was for a remote Part/Full-time opening available at the Luma in the NYC area. Well I'm someone who enjoys coding and learning with Python as far as learning purposes/hobbies go. Plus, I'm someone who has been going the self taught route trying to break into the IT field/Python Development world. I also have interests in some of the things mentioned in the post such as finance/trading and business. But, more than anything.. I'd looking to further learn and grow in my skills as far as Python development goes. I don't have much experience with Django Web development but feel I can learn and pick up on it as well as with any other technology requirements quickly. After quickly reading your post on Hacker News I was encouraged and interested to reach out and contact you for more info. So with that said, here I am..and I wanted to inquire to find out if this opening is available? Or has it been filled? Also would you allow for training of junior developers to get up to speed? I had to ask because but I wasn't sure if you meant junior or for more seasoned developers. Also, you have a contact number to learn more about this position or information on the things you require in regards to the nature of the job to increase one's chances to be a part of your startup team? Any help in this matter will be greatly appreciated. Thank you Feel free to contact me at: pydeveloper22@gmail.com --K

porpoisely 8y ago

Nice write up. But I want to point out that interest rates are leading indicators of the economy, it doesn't follow the economy. It's why the inverted yield curve is one of the widely looked at indicators for future economic health. So the yield curve inversion isn't saying the economy right now isn't doing well. What it is saying is that the market ( or a large percentage of institutional investors ) think the economy won't do well in the future. As you noted, it's only a slight inversion of only the 3 and 5 year, so it isn't that alarming for the moment. Just as important as the yield curve is what the FED is going to do with interest rates. If they consistently raise it every quarter for the foreseeable future, then the odds of a recession will increase considerably.

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nodesocket 8y ago

Capital One is offering money market savings accounts earning 2.0%, with no caps, and no time limits. Sure, I could buy a 1 year bond, and earn the extra .72%, but I rather have the flexibility to withdraw at anytime with the Capital One money market account.

panarky 8y ago

Shorter summary - historically, yield curve inversions have been pretty reliable predictors of recession. There are no certainties, of course, but the probability is pretty high that in the next 6 to 24 months we'll see negative economic growth and increasing unemployment.

rafkin98 8y ago

The classic recession signal that most follow is a 2-10 inversion.

dskhatri 8y ago

[1] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield https://www.treasury.gov/resource-center/data-chart-center/i...

75dvtwin 8y ago

@chadash thx for the explanation. With regards to > that investors think that rates of return on government bonds are going to go down in the future. Does it mean that investors think that US government will pay 'less interest' in the future for these 5 year bonds ? If yes, does that mean that investors think that US government will be willing to pay less to its lendors (the bond holders). Which, would also mean that bond buyers think it is good time now to lock in a higher rate. (seems like a good thing if one is a US taxpayer, if the gov will pay less to money lenders, unless US people are starving...). For example, Ukrain's 3 year bond pays 18% http://www.worldgovernmentbonds.com/bond-historical-data/ukraine/3-years/ http://www.worldgovernmentbonds.com/bond-historical-data/ukr...

chadash 8y ago
I didn't want to get too much into the weeds, but it's actually the market [1] that determines the rates. What the US wishes to pay is irrelevant. As stated in my original post, the treasury sets an interest rate and a face value on its bonds. Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more). So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields. [1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now. [2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example. [3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).

gota 8y ago

Great write up. Also in layman's terms: what do investors generally do when gearing up towards a recession, other than buy long-term (and low-yield) bonds in advance?

c3534l 8y ago

> The US government is constitutionally bound to pay its debts Since when? Please point me to the part of the constitution that says that.

shaki-dora 8y ago
Since 17someting: Article VI > All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution. It requires a minimum of good faith, which you possibly lack. But it clearly implies that debt exists, and that it can be valid. The fact that valid debt is to be repaid is not clearly spelled out in the constitution, because the founding fathers did not believe there would ever be a time where idiot vandals trashed about requiring every minute detail to be proven from first principle.
- c3534l 8y ago
  That doesn't mean the government can't default on its debts, it means that the new government would assume the debts of its predecessor. Context from Wikipedia: > The states and the Confederation Congress both incurred large debts during the Revolutionary War, and how to repay those debts became a major issue of debate following the War. Some States paid off their war debts and others did not. Federal assumption of the states' war debts became a major issue in the deliberations of the Constitutional Convention. As for the rest of your comments, I used to like it when HackerNews was somewhat civil.
- dragonwriter 8y ago
  Art. VI only says that the US under the Constitution chose to assume the debts of the US under the AoC. What seems closer to what you want is the first part of Section 4 of the 14th Amendment: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” (Which still, strictly, doesn't say the debt will be paid, only that it's validity will not be questioned.)
chadash 8y ago

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