10 ms·

U.S. Treasury Yield Curve Inverts for First Time Since 2007

180 points by ramoz 8y ago

ckdarby 8y ago
Can someone explain what kind of impact this has?
- alanbernstein 8y ago
  To my understanding, this is a metric, so it's not quite right to say that it has an "impact". But, from the article: > Inversion is considered a reliable harbinger of recession in the U.S., within roughly the next 18 months.
- maroonedanchor 8y ago
  Lending money for longer term is disadvantaged vs. shorter term so borrowing is impacted. This leads to less stability and in the past has been a fairly good indicator of an upcoming recession. Past performance is not an indicator of future returns.
- arthurcolle 8y ago
  When investors buy bonds, specifically US Treasury securities, the relationship between the yield and the time to maturity (2,3,5,7,10,30 years) is generally upward sloping because, as the logic goes, the longer dated securities should have a higher yield because the investor wants to get paid more since they are parting with their money for longer. https://en.wikipedia.org/wiki/Yield_curve#/media/File:Yield_curve_20180513.png https://en.wikipedia.org/wiki/Yield_curve#/media/File:Yield_... something like that is usually "what's expected". When we see yield curve inversions, usually beginning with just a small 'kink' on some point in the curve, that means that the yield at a point further out is lower than a shorter dated security. When the yield curve inverts like this, it means that demand for shorter-dated bonds is higher than longer-dated bonds, and because the duration of longer-dated bonds is higher than shorter-dated bonds, when demand falls for longer-dated bonds, those investors will instead buy shorter-dated bonds. Can also mean that the market believes that a recession is coming, so there's a flight to safety out of equities and into shorter-dated treasuries. That's the gist of it
  - otherjason 8y ago
    I think you have the relationship between yield and demand backwards. The yield of a bond and its price are inversely related, so an inverted yield curve (lower yields at longer durations) implies the opposite of what you said: there is higher demand for longer-dated bonds relative to short-dated ones. One way to interpret this is that investors expect poorer asset returns in the short term, so they are willing to lock in a lower yield for a long period of time instead of, for example, taking significant losses in the stock market.
  - jussij 8y ago
    > When the yield curve inverts like this, it means that demand for shorter-dated bonds is higher than longer-dated bonds That is true for a booming economy, but not for the inverted yield case. It all comes down to where investors think the Fed is headed when it comes to interest rates. For a booming economy the Fed puts up rates in an effort to slow growth. For a lagging economy the Fed cuts the rate in an effort to stimulate growth. Now consider the investor wanting to invest in bonds hoping for the best possible return. In a booming economy you would only invest in short term 5 year bonds because chances are future interest rates will be higher than what you are currently getting. But for a slowing economy it might be better to invest in the 10 year bond, to lock in a long term interest rate only because in the future interest rates may well be lower. Now consider the supply and demand forces that also come into play. When the demand is high the price goes up and the yield goes down and when the demand is low the price goes down and the yield goes up. So when you have large numbers of investors wanting to get out of 5 year bonds (i.e. high selling) and into 10 year bonds (i.e. high buying) you get this inverted yield situation.
    - nramos3 8y ago
      Perfect in layman’s terms. The Federal reserve keeps spewing the economy is so strong and nobody in the bond world is buying it, thus locking in the long term rates now (they’ll never admit a recession is coming, or blindly don’t know). It’s interesting to note the now 60% of bonds are now inverted, it was just 50% a day ago!!! Even if one was to say this is just one indicator look at Canada -50% inverted and housing bubble currently
- defertoreptar 8y ago
  Apparently it has predicted the last seven recessions. People are using the expression "self-fulfilling prophecy."
  - refurb 8y ago
    Exactly. Every one looks at the last 10 years of a bull market and says “recession is coming!”. Many of these people are bidding on these same bonds. So does the inversion signal a coming recession or just the belief of a coming recession?
  - AnimalMuppet 8y ago
    It may have predicted ten out of the last seven recessions. That is, sometimes the yield curve inverts and the recession doesn't happen. So it's not quite a self-fulfilling prophesy - though it still may be a sometimes-self-fulfilling prophesy...
    - dajohnson89 8y ago
      correct. we can't determine the usefulness of this statistic without a false positive rate.
wk0 8y ago
notably, the 2 & 10 year has not yet inverted https://fred.stlouisfed.org/series/T10Y2Y https://fred.stlouisfed.org/series/T10Y2Y
- nodesocket 8y ago
  In December it was the 3 and 5 year which inverted, and today it was the 3 month and 10 year. Typically I’ve understood the biggest one to watch is the 2 and 10 year though.
spchampion2 8y ago
Here's a simple example for explaining what this means. Imagine I'm the government, and I sell bonds where I promise I'll pay you back $100 in 5 years or 10 years. Because I'm the government, and I can print money to repay any debt, these bonds are considered very low risk - sometimes they're even called risk free. The market bids on these bonds, and the market price is public information. Let's say that people are paying $90 for a 5 year bond, meaning they pay $90 today and get $100 in 5 years. Knowing this, we can work out that this is equivalent to a yearly interest rate of 2.13%. Now we expect that the computed interest rate for the 10 year bond should be higher than the 5 year bond. People want to be compensated for locking up their money for longer. So let's also say people are paying $80 for a 10 year bond, which works out to an interest rate of 2.26%. These numbers fluctuate up and down every day, and they generally rise and fall with the prevailing interest rates. Here's the key question - what happens if the 10 year interest rate falls below the 5 year rate? There are a lot of possible reasons, but this often indicates that investors think a recession is around the corner. The reason is that investors are betting that the prevailing interest rates will drop. If interest rates drop, then future bond purchases may have much lower interest rates than those bought today. It turns out you might like the idea of getting 2% interest for 10 years rather than 2.13% for 5 years and then 0.5% for the next 5 years.
- WillPostForFood 8y ago
  Interestingly, the US has never had a recession that wasn't preceded by an inverted yield curve, but not every yield curve inversion has been followed by a recession.
  - hire_charts 8y ago
    Can't you essentially fabricate this statistic by controlling for the amount of time that counts as "before", assuming the inverted curves happen more often than recessions?
    - mannykannot 8y ago
      I am guessing that "before" means that the inversion persisted until the economy was technically in recession.
whb07 8y ago
Most of the commentary on the signaling of an inverted yield curve is all parroted by everyone else as “ominous”. Catherine Wood is the only person I’ve seen to go against the grain on this one [0]. Essentially, she notes that the yield curve has been inverted roughly 50% of the time in the late 19th century and early 20th century. Furthermore, during the times it was inverted, it marked periods of strong growth! It’s an interesting take as everyone else conveniently (more like lazy) are not doing the research and going back as far back as late 18th century. Her point of view is contrarian and refreshingly unique! [0] https://www.cnbc.com/2018/12/04/the-economy-will-surprise-to-the-high-next-year-arks-catherine-wood.html https://www.cnbc.com/2018/12/04/the-economy-will-surprise-to...
- deleted 8y ago
  [deleted]
- dragonwriter 8y ago
  > Essentially, she notes that the yield curve has been inverted roughly 50% of the time in the late 19th century and early 20th century. Actually, she says specifically 1800-1929, which is an interesting choice because AFAICT the “3-month" security (the 13-week T-bill) referenced when discussing the 3m/10y inversion (the one discussed here as a key indicator) was first regularly issued in 1929. [0] The behavior of the markets when either or both of the instruments in the analysis were not regularly issued is obviously not comparable. (Further, when they aren't both regularly issued, assessing how much of the time an inversion was in effect is, at best, creative extrapolation, and more likely outright fiction.) > It’s an interesting take as everyone else conveniently (more like lazy) are not doing the research and going back as far back as late 18th century. So lazy of everyone else to only study a measure as far back as the basic premises of using the measure are valid and the components that make it up actually exist. [0] https://www.treasurydirect.gov/indiv/research/history/histmkt/histmkt_bills.htm https://www.treasurydirect.gov/indiv/research/history/histmk...
  - dnautics 8y ago
    wouldn't the motion of the yield curve in that era be very different given that the dollar was long-term noninflationary? if you expect the dollar to deflate in the long term, you might be OK accepting a lower long term yield.
buzzdenver 8y ago
I am surprised this is not happening more frequently. An inversion between the 1 and 5 year bonds just means that the expected average yield for each of the next 5 years is less than the yield for next year. Statistically that should be the case 50% of the time. Treasure bonds are liquid, so buying a 5 year one does not mean that you have to hold it to maturity. Somebody tell me where I'm wrong.
- pishpash 8y ago
  Where are you getting this 50% from? Also, you're ignoring that there is more price risk in long bonds even if you can sell them, so there should anyway be a term premium (upward-sloping curve) even if the expected interest rate over five years is constant.
- sf_rob 8y ago
  >Statistically that should be the case 50% of the time. Only if the risk premium is the same. >Treasure bonds are liquid, so buying a 5 year one does not mean that you have to hold it to maturity. Here you claim that the risk premium is the same because it's liquid. However the term is not the same so you'll be hit with a bigger effect when short term interest rates change on a longer time horizon instrument.
- nickles 8y ago
  There are a few factors that cause one to expect a monotonically increasing, concave yield curve [0]. Firstly, one must consider the term premium [1]. In short, you expect to be compensated more for lending money for a longer period of time. Consider lending money for two years. You could lend your money in two single year-long increments, in which case you would compound your gains from the first year when you lend out the second year. If you lend in a single, two year-long commitment, you rationally expect, all else being equal, to earn as much as you would have by lending as described previously. This drives the general upwards slope (or contango) of the yield curve. Next, consider a credit component. When you lend someone money, how likely is it that you are paid back? If you expect there is default risk, you factor that into the interest rate you demand. As the tenor of the bond increases, the risk of default increases. However, the extra interest you demand for credit risk also decreases as time goes out. Why? What are the chances that someone defaults on a loan between 5 and 10 years? Probably greater than the risk that the party defaults between 10 and 15 years. This drives the concavity of the yield curve. Finally, the movement in the curve is driven by expectations of future interest rates, as determined by Federal Reserve policy. Fed typically acts at the short end of the curve. In its tool chest, fed can manipulate rates like the fed funds rate, IOER, and ON REPO. As the economy improves, fed will raise rates. When economic outlook declines, fed will lower rates. If you expect that rates will be higher in the future, you will demand higher yields for longer dated bonds, since your invested money will earn less of a premium to interest rates in the future relative to where you invested today. On the flip side, if you expect interest rates to decline, you will want to lock in your money now, so you purchase longer dated bonds, since you do not expect to be able to get as high a yield in the future. This action at the long end of the curve, coupled with fed policy at the short end, ultimately drives yield curve fluctuations. [0] https://obliviousinvestor.com/wp-content/uploads/2012/07/yieldcurves.png https://obliviousinvestor.com/wp-content/uploads/2012/07/yie... [1] https://www.bloomberg.com/news/articles/2017-10-30/what-s-a-term-premium-and-where-did-mine-go-quicktake-q-a https://www.bloomberg.com/news/articles/2017-10-30/what-s-a-...
potatofarmer45 8y ago
A lot of the people in Finance are surprisingly superstitious. I had a boss once who would not conduct trades if he saw a totally unrelated bad omen. The treasury yield curve is a measure of expectations. It's a market marker that is the result of traders and reflects the overall view of the economy. Having said that, it's also taken on a mythical status where now that it has inverted, people will start planning for a recession which may in turn lead to happening much sooner/if at all. It's a self fulfilling prophecy in a way where the expectation of a recession leads you act in a way that leads to that outcome.
- Invictus0 8y ago
  Is it that surprising though? For a group of people that believes they can predict the future?
- tehlike 8y ago
  similar story with charting.
Varcht 8y ago
What would it cost to make this happen?
- deleted 8y ago
  [deleted]
aznpwnzor 8y ago
Hmm for some reason I thought this was already the case actually. I was looking at Ally CD rates a few weeks ago, and I saw an inversion there and I just chalked that up to the CD rates being dependent on the yield curve. Does it?
- levthedev 8y ago
  There was a less extreme yield curve inversion a few months ago, which is likely what you're referring to. But it wasn't so far reaching as the current inversion, which puts the 1 year Treasury over the 10 year.
apo 8y ago
> While the 3-month to 10-year spread “has a relatively decent track record of predicting recessions, it suffers from a timing problem,” said TD Securities U.S. rates strategist Gennadiy Goldberg. “Its inversion can suggest a recession occurred six months ago or will occur two years from now.” Not just "relatively decent," but perfect over the last seven recessions at least. When the 3-month treasury yields more than the 10-year treasury, the economy has been in recession within two years 7/7 times. https://seekingalpha.com/article/4250287-fully-inverted-yield-curve-consequently-recession-coming-doorstep-soon https://seekingalpha.com/article/4250287-fully-inverted-yiel... There are a lot of leading economic indicators, but this one beats them all in terms of reliability. There's one complicating factor that I don't see getting the attention it deserves. Unlike previous cycles, the Fed has been actively manipulating long-term yields for over a decade. That used to be taboo, but not anymore. The Fed holds trillions of dollars of long-term treasuries, accumulated under its QE/X programs. The ownership of that debt by the Fed puts downward pressure on long-term yields. Recently, the Fed started allowing its long bonds to mature through its "quantitative tightening" (QT) program. That pressure (which really ramped up a few months ago) may have temporarily pumped up yields, and in so doing delayed a yield curve inversion signal. The status going forward of QT and the Fed's gargantuan balance sheet is anybody's guess. My bet is the Fed is done with QT until at least after the 2020 election. If things really start going south, watch for the Fed to begin buying stocks directly like the Bank of Japan has been doing for years. That and negative-yielding treasuries. Either way, this is unprecedented territory. Signals could be quite confounded for the foreseeable future - which means policy makers are winging it. They almost certainly will make the wrong decisions.
- cinquemb 8y ago
  > There's one complicating factor that I don't see getting the attention it deserves. Unlike previous cycles, the Fed has been actively manipulating long-term yields for over a decade. Yeah, very few are talking about what has been going on in the back end by them and how it distorts the curve gymnastics, but even the fed warned last year that it (long end inversion) might not be a reliable signal as it once was (because of their dealings) implying that things may come faster than people may expect if that was what they were only looking at. The big problem is that people are now starting to realize is that even though QE can provide liquidity, it can't provide solvency: more debt just makes it worse when banks try to lend out their fresh reserves they were able to get from their trade in for liquid assets from the fed, especially if the top line of companies stays the same or starts to deteriorate, even setting aside companies that have been skirting along on negative income for so long because they were able to keep rolling over debt at ZLB. >The status going forward of QT and the Fed's gargantuan balance sheet is anybody's guess. My bet is the Fed is done with QT until at least after the 2020 election. QT is still on, just tweaked now: " - Begin tapering the “runoff” of Treasury securities in May. - End the runoff of Treasury securities on September 30. - Continue shedding mortgage-backed securities (MBS) at the current maximum of $20 billion a month, essentially until they’re gone. - After September, reinvest MBS principal payments into Treasury securities. Chair Jerome Powell said during the press conference that the balance sheet will by then be “a bit above $3.5 trillion.” - The balance sheet will remain at this level even as the economy grows, thus slowly shrinking in relationship to GDP. - The Fed may sell MBS outright to speed up the process of getting rid of them. - No decision has been made on the delicate issue of the maturity composition of the balance sheet – which would require buying short-term bills for the first time in years to replace longer-term notes and bonds." [0][1] >They almost certainly will make the wrong decisions. Yes they will, and plenty of traders are betting on it. It's amazing that some people think CB's have control of this ship… but hey, someone needs to be on the other side of the trade. [0] https://wolfstreet.com/2019/03/20/feds-new-balance-sheet-plan-get-rid-of-mbs/ https://wolfstreet.com/2019/03/20/feds-new-balance-sheet-pla... [1] https://www.federalreserve.gov/newsevents/pressreleases/monetary20190320c.htm https://www.federalreserve.gov/newsevents/pressreleases/mone...
mattmaroon 8y ago
I'm not sure that the yield curve isn't us being fooled by randomness. Everyone is looking at every metric for predictive ability. The odds that one of them went 7/7 have to approach 1.
- all_blue_chucks 8y ago
  Yield curve inversion is something like like 15/7, actually.

180 points by ramoz 8y ago

ckdarby 8y ago

Can someone explain what kind of impact this has?

alanbernstein 8y ago
To my understanding, this is a metric, so it's not quite right to say that it has an "impact". But, from the article: > Inversion is considered a reliable harbinger of recession in the U.S., within roughly the next 18 months.
maroonedanchor 8y ago
Lending money for longer term is disadvantaged vs. shorter term so borrowing is impacted. This leads to less stability and in the past has been a fairly good indicator of an upcoming recession. Past performance is not an indicator of future returns.
arthurcolle 8y ago
When investors buy bonds, specifically US Treasury securities, the relationship between the yield and the time to maturity (2,3,5,7,10,30 years) is generally upward sloping because, as the logic goes, the longer dated securities should have a higher yield because the investor wants to get paid more since they are parting with their money for longer. https://en.wikipedia.org/wiki/Yield_curve#/media/File:Yield_curve_20180513.png https://en.wikipedia.org/wiki/Yield_curve#/media/File:Yield_... something like that is usually "what's expected". When we see yield curve inversions, usually beginning with just a small 'kink' on some point in the curve, that means that the yield at a point further out is lower than a shorter dated security. When the yield curve inverts like this, it means that demand for shorter-dated bonds is higher than longer-dated bonds, and because the duration of longer-dated bonds is higher than shorter-dated bonds, when demand falls for longer-dated bonds, those investors will instead buy shorter-dated bonds. Can also mean that the market believes that a recession is coming, so there's a flight to safety out of equities and into shorter-dated treasuries. That's the gist of it
- otherjason 8y ago
  I think you have the relationship between yield and demand backwards. The yield of a bond and its price are inversely related, so an inverted yield curve (lower yields at longer durations) implies the opposite of what you said: there is higher demand for longer-dated bonds relative to short-dated ones. One way to interpret this is that investors expect poorer asset returns in the short term, so they are willing to lock in a lower yield for a long period of time instead of, for example, taking significant losses in the stock market.
- jussij 8y ago
  > When the yield curve inverts like this, it means that demand for shorter-dated bonds is higher than longer-dated bonds That is true for a booming economy, but not for the inverted yield case. It all comes down to where investors think the Fed is headed when it comes to interest rates. For a booming economy the Fed puts up rates in an effort to slow growth. For a lagging economy the Fed cuts the rate in an effort to stimulate growth. Now consider the investor wanting to invest in bonds hoping for the best possible return. In a booming economy you would only invest in short term 5 year bonds because chances are future interest rates will be higher than what you are currently getting. But for a slowing economy it might be better to invest in the 10 year bond, to lock in a long term interest rate only because in the future interest rates may well be lower. Now consider the supply and demand forces that also come into play. When the demand is high the price goes up and the yield goes down and when the demand is low the price goes down and the yield goes up. So when you have large numbers of investors wanting to get out of 5 year bonds (i.e. high selling) and into 10 year bonds (i.e. high buying) you get this inverted yield situation.
  - nramos3 8y ago
    Perfect in layman’s terms. The Federal reserve keeps spewing the economy is so strong and nobody in the bond world is buying it, thus locking in the long term rates now (they’ll never admit a recession is coming, or blindly don’t know). It’s interesting to note the now 60% of bonds are now inverted, it was just 50% a day ago!!! Even if one was to say this is just one indicator look at Canada -50% inverted and housing bubble currently
defertoreptar 8y ago
Apparently it has predicted the last seven recessions. People are using the expression "self-fulfilling prophecy."
- refurb 8y ago
  Exactly. Every one looks at the last 10 years of a bull market and says “recession is coming!”. Many of these people are bidding on these same bonds. So does the inversion signal a coming recession or just the belief of a coming recession?
- AnimalMuppet 8y ago
  It may have predicted ten out of the last seven recessions. That is, sometimes the yield curve inverts and the recession doesn't happen. So it's not quite a self-fulfilling prophesy - though it still may be a sometimes-self-fulfilling prophesy...
  - dajohnson89 8y ago
    correct. we can't determine the usefulness of this statistic without a false positive rate.

wk0 8y ago

notably, the 2 & 10 year has not yet inverted https://fred.stlouisfed.org/series/T10Y2Y https://fred.stlouisfed.org/series/T10Y2Y

nodesocket 8y ago
In December it was the 3 and 5 year which inverted, and today it was the 3 month and 10 year. Typically I’ve understood the biggest one to watch is the 2 and 10 year though.

spchampion2 8y ago

Here's a simple example for explaining what this means. Imagine I'm the government, and I sell bonds where I promise I'll pay you back $100 in 5 years or 10 years. Because I'm the government, and I can print money to repay any debt, these bonds are considered very low risk - sometimes they're even called risk free. The market bids on these bonds, and the market price is public information. Let's say that people are paying $90 for a 5 year bond, meaning they pay $90 today and get $100 in 5 years. Knowing this, we can work out that this is equivalent to a yearly interest rate of 2.13%. Now we expect that the computed interest rate for the 10 year bond should be higher than the 5 year bond. People want to be compensated for locking up their money for longer. So let's also say people are paying $80 for a 10 year bond, which works out to an interest rate of 2.26%. These numbers fluctuate up and down every day, and they generally rise and fall with the prevailing interest rates. Here's the key question - what happens if the 10 year interest rate falls below the 5 year rate? There are a lot of possible reasons, but this often indicates that investors think a recession is around the corner. The reason is that investors are betting that the prevailing interest rates will drop. If interest rates drop, then future bond purchases may have much lower interest rates than those bought today. It turns out you might like the idea of getting 2% interest for 10 years rather than 2.13% for 5 years and then 0.5% for the next 5 years.

WillPostForFood 8y ago
Interestingly, the US has never had a recession that wasn't preceded by an inverted yield curve, but not every yield curve inversion has been followed by a recession.
- hire_charts 8y ago
  Can't you essentially fabricate this statistic by controlling for the amount of time that counts as "before", assuming the inverted curves happen more often than recessions?
  - mannykannot 8y ago
    I am guessing that "before" means that the inversion persisted until the economy was technically in recession.

whb07 8y ago

Most of the commentary on the signaling of an inverted yield curve is all parroted by everyone else as “ominous”. Catherine Wood is the only person I’ve seen to go against the grain on this one [0]. Essentially, she notes that the yield curve has been inverted roughly 50% of the time in the late 19th century and early 20th century. Furthermore, during the times it was inverted, it marked periods of strong growth! It’s an interesting take as everyone else conveniently (more like lazy) are not doing the research and going back as far back as late 18th century. Her point of view is contrarian and refreshingly unique! [0] https://www.cnbc.com/2018/12/04/the-economy-will-surprise-to-the-high-next-year-arks-catherine-wood.html https://www.cnbc.com/2018/12/04/the-economy-will-surprise-to...

deleted 8y ago
[deleted]
dragonwriter 8y ago
> Essentially, she notes that the yield curve has been inverted roughly 50% of the time in the late 19th century and early 20th century. Actually, she says specifically 1800-1929, which is an interesting choice because AFAICT the “3-month" security (the 13-week T-bill) referenced when discussing the 3m/10y inversion (the one discussed here as a key indicator) was first regularly issued in 1929. [0] The behavior of the markets when either or both of the instruments in the analysis were not regularly issued is obviously not comparable. (Further, when they aren't both regularly issued, assessing how much of the time an inversion was in effect is, at best, creative extrapolation, and more likely outright fiction.) > It’s an interesting take as everyone else conveniently (more like lazy) are not doing the research and going back as far back as late 18th century. So lazy of everyone else to only study a measure as far back as the basic premises of using the measure are valid and the components that make it up actually exist. [0] https://www.treasurydirect.gov/indiv/research/history/histmkt/histmkt_bills.htm https://www.treasurydirect.gov/indiv/research/history/histmk...
- dnautics 8y ago
  wouldn't the motion of the yield curve in that era be very different given that the dollar was long-term noninflationary? if you expect the dollar to deflate in the long term, you might be OK accepting a lower long term yield.

buzzdenver 8y ago

I am surprised this is not happening more frequently. An inversion between the 1 and 5 year bonds just means that the expected average yield for each of the next 5 years is less than the yield for next year. Statistically that should be the case 50% of the time. Treasure bonds are liquid, so buying a 5 year one does not mean that you have to hold it to maturity. Somebody tell me where I'm wrong.

pishpash 8y ago
Where are you getting this 50% from? Also, you're ignoring that there is more price risk in long bonds even if you can sell them, so there should anyway be a term premium (upward-sloping curve) even if the expected interest rate over five years is constant.
sf_rob 8y ago
>Statistically that should be the case 50% of the time. Only if the risk premium is the same. >Treasure bonds are liquid, so buying a 5 year one does not mean that you have to hold it to maturity. Here you claim that the risk premium is the same because it's liquid. However the term is not the same so you'll be hit with a bigger effect when short term interest rates change on a longer time horizon instrument.
nickles 8y ago
There are a few factors that cause one to expect a monotonically increasing, concave yield curve [0]. Firstly, one must consider the term premium [1]. In short, you expect to be compensated more for lending money for a longer period of time. Consider lending money for two years. You could lend your money in two single year-long increments, in which case you would compound your gains from the first year when you lend out the second year. If you lend in a single, two year-long commitment, you rationally expect, all else being equal, to earn as much as you would have by lending as described previously. This drives the general upwards slope (or contango) of the yield curve. Next, consider a credit component. When you lend someone money, how likely is it that you are paid back? If you expect there is default risk, you factor that into the interest rate you demand. As the tenor of the bond increases, the risk of default increases. However, the extra interest you demand for credit risk also decreases as time goes out. Why? What are the chances that someone defaults on a loan between 5 and 10 years? Probably greater than the risk that the party defaults between 10 and 15 years. This drives the concavity of the yield curve. Finally, the movement in the curve is driven by expectations of future interest rates, as determined by Federal Reserve policy. Fed typically acts at the short end of the curve. In its tool chest, fed can manipulate rates like the fed funds rate, IOER, and ON REPO. As the economy improves, fed will raise rates. When economic outlook declines, fed will lower rates. If you expect that rates will be higher in the future, you will demand higher yields for longer dated bonds, since your invested money will earn less of a premium to interest rates in the future relative to where you invested today. On the flip side, if you expect interest rates to decline, you will want to lock in your money now, so you purchase longer dated bonds, since you do not expect to be able to get as high a yield in the future. This action at the long end of the curve, coupled with fed policy at the short end, ultimately drives yield curve fluctuations. [0] https://obliviousinvestor.com/wp-content/uploads/2012/07/yieldcurves.png https://obliviousinvestor.com/wp-content/uploads/2012/07/yie... [1] https://www.bloomberg.com/news/articles/2017-10-30/what-s-a-term-premium-and-where-did-mine-go-quicktake-q-a https://www.bloomberg.com/news/articles/2017-10-30/what-s-a-...

potatofarmer45 8y ago

A lot of the people in Finance are surprisingly superstitious. I had a boss once who would not conduct trades if he saw a totally unrelated bad omen. The treasury yield curve is a measure of expectations. It's a market marker that is the result of traders and reflects the overall view of the economy. Having said that, it's also taken on a mythical status where now that it has inverted, people will start planning for a recession which may in turn lead to happening much sooner/if at all. It's a self fulfilling prophecy in a way where the expectation of a recession leads you act in a way that leads to that outcome.

Invictus0 8y ago
Is it that surprising though? For a group of people that believes they can predict the future?
tehlike 8y ago
similar story with charting.

Varcht 8y ago

What would it cost to make this happen?

deleted 8y ago
[deleted]

aznpwnzor 8y ago

Hmm for some reason I thought this was already the case actually. I was looking at Ally CD rates a few weeks ago, and I saw an inversion there and I just chalked that up to the CD rates being dependent on the yield curve. Does it?

levthedev 8y ago
There was a less extreme yield curve inversion a few months ago, which is likely what you're referring to. But it wasn't so far reaching as the current inversion, which puts the 1 year Treasury over the 10 year.

apo 8y ago

> While the 3-month to 10-year spread “has a relatively decent track record of predicting recessions, it suffers from a timing problem,” said TD Securities U.S. rates strategist Gennadiy Goldberg. “Its inversion can suggest a recession occurred six months ago or will occur two years from now.” Not just "relatively decent," but perfect over the last seven recessions at least. When the 3-month treasury yields more than the 10-year treasury, the economy has been in recession within two years 7/7 times. https://seekingalpha.com/article/4250287-fully-inverted-yield-curve-consequently-recession-coming-doorstep-soon https://seekingalpha.com/article/4250287-fully-inverted-yiel... There are a lot of leading economic indicators, but this one beats them all in terms of reliability. There's one complicating factor that I don't see getting the attention it deserves. Unlike previous cycles, the Fed has been actively manipulating long-term yields for over a decade. That used to be taboo, but not anymore. The Fed holds trillions of dollars of long-term treasuries, accumulated under its QE/X programs. The ownership of that debt by the Fed puts downward pressure on long-term yields. Recently, the Fed started allowing its long bonds to mature through its "quantitative tightening" (QT) program. That pressure (which really ramped up a few months ago) may have temporarily pumped up yields, and in so doing delayed a yield curve inversion signal. The status going forward of QT and the Fed's gargantuan balance sheet is anybody's guess. My bet is the Fed is done with QT until at least after the 2020 election. If things really start going south, watch for the Fed to begin buying stocks directly like the Bank of Japan has been doing for years. That and negative-yielding treasuries. Either way, this is unprecedented territory. Signals could be quite confounded for the foreseeable future - which means policy makers are winging it. They almost certainly will make the wrong decisions.

cinquemb 8y ago
> There's one complicating factor that I don't see getting the attention it deserves. Unlike previous cycles, the Fed has been actively manipulating long-term yields for over a decade. Yeah, very few are talking about what has been going on in the back end by them and how it distorts the curve gymnastics, but even the fed warned last year that it (long end inversion) might not be a reliable signal as it once was (because of their dealings) implying that things may come faster than people may expect if that was what they were only looking at. The big problem is that people are now starting to realize is that even though QE can provide liquidity, it can't provide solvency: more debt just makes it worse when banks try to lend out their fresh reserves they were able to get from their trade in for liquid assets from the fed, especially if the top line of companies stays the same or starts to deteriorate, even setting aside companies that have been skirting along on negative income for so long because they were able to keep rolling over debt at ZLB. >The status going forward of QT and the Fed's gargantuan balance sheet is anybody's guess. My bet is the Fed is done with QT until at least after the 2020 election. QT is still on, just tweaked now: " - Begin tapering the “runoff” of Treasury securities in May. - End the runoff of Treasury securities on September 30. - Continue shedding mortgage-backed securities (MBS) at the current maximum of $20 billion a month, essentially until they’re gone. - After September, reinvest MBS principal payments into Treasury securities. Chair Jerome Powell said during the press conference that the balance sheet will by then be “a bit above $3.5 trillion.” - The balance sheet will remain at this level even as the economy grows, thus slowly shrinking in relationship to GDP. - The Fed may sell MBS outright to speed up the process of getting rid of them. - No decision has been made on the delicate issue of the maturity composition of the balance sheet – which would require buying short-term bills for the first time in years to replace longer-term notes and bonds." [0][1] >They almost certainly will make the wrong decisions. Yes they will, and plenty of traders are betting on it. It's amazing that some people think CB's have control of this ship… but hey, someone needs to be on the other side of the trade. [0] https://wolfstreet.com/2019/03/20/feds-new-balance-sheet-plan-get-rid-of-mbs/ https://wolfstreet.com/2019/03/20/feds-new-balance-sheet-pla... [1] https://www.federalreserve.gov/newsevents/pressreleases/monetary20190320c.htm https://www.federalreserve.gov/newsevents/pressreleases/mone...

mattmaroon 8y ago

I'm not sure that the yield curve isn't us being fooled by randomness. Everyone is looking at every metric for predictive ability. The odds that one of them went 7/7 have to approach 1.

all_blue_chucks 8y ago
Yield curve inversion is something like like 15/7, actually.