8 ms·

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 yea

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.
    - tfehring 8y ago
      Not quite - see https://fred.stlouisfed.org/series/T10Y3M https://fred.stlouisfed.org/series/T10Y3M for reference. The grey areas are recessions, and values below 0 are inversions. To address the GP’s point, the relationship could be fabricated, but the data don’t indicate that that’s happening.
- Kinnard 8y ago
  This doesn't account for recessions before the creation of the Federal Reserve.
- nickles 8y ago
  > the US has never had a recession that wasn’t preceded by an inverted yield curve This is incorrect. Most recessions in the post WW2 period have been preceded by an inversion of the 3m/10y UST curve, but it did not precede a few recessions in the USA during the first half of the 20th century. [0] http://bonddad.blogspot.com/2011/07/yield-curve-and-pre-ww2-recessions.html http://bonddad.blogspot.com/2011/07/yield-curve-and-pre-ww2-...
- sytelus 8y ago
  When large number of people are betting there is recession, there will a recession simply because people are collectively contracting their consumption in anticipation.
phkahler 8y ago
I'm actually hoping the fed refuses to lower rates. Let things dip a little rather than try to regulate the economy so much. Them jerking around rates was part of the trigger for 2008. Long term I think rates need to be higher anyway. So here's to hoping the speculators are wrong!
- deleted 8y ago
  [deleted]
- JamesBarney 8y ago
  Why do you think rates need to be higher? Inflation has been to high or unemployment has been too low? And I've never heard anyone say the fed caused the 2008 recession. It's pretty much universally agreed upon it was finance blowing up.
  - mindslight 8y ago
    Inflation has been way too high. Not uniformly, but chiefly housing where new money is introduced into the consumer realm. In an inflation-neutral environment, one would expect the prices of manufactured goods to be trending slowly downwards. After all, producing something less expensively is exactly what economic competition leads to.
    - irq11 8y ago
      Housing, startups, art, cars, watches...pretty much everything collectible or rare has seen its value skyrocket since the great recession. The big pool of money has been sloshing between asset classes for a while now, but it doesn’t get reflected in inflation metrics.
      - JamesBarney 8y ago
        I think this is a combination of low interest rates making the opportunity cost of owning collectibles much lower and rising inequality driving up the purchasing power of collectors.
bobcostas55 8y ago
>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. This is absolutely not the reason they're considered low risk. If the USG tried to repay its debts by printing money, debtholders uninsured against inflation would lose tons of money. The expectation that they're _not_ going to print money to repay debt is part of why it's so safe.
- dragonwriter 8y ago
  > If the USG tried to repay its debts by printing money, debtholders uninsured against inflation would lose tons of money. No, they'd lose anticipated value of the debt repayment compared to other goods and services if the gov did that without other compensatory policy, but get all the money they expected. > The expectation that they're _not_ going to print money to repay debt is part of why it's so safe. You are confusing “why dollars are safe” with “why US government debt is safe”. The expectation that the money supply will be managed, in total, for stability and reasonably low inflation is why dollars are safe. (The expectation of not monetizing the debt, to the extent it is relevant at all, is relevant here.) The expectation that the US government will not in any case default is why, among dollar-denominated instruments, US government debt is considered almost as safe as actual dollars.
  - bobcostas55 8y ago
    You're acting as if default risk is the only relevant risk to creditors. Inflation risk is just as real. You can't just wish it away by saying it's "why dollars are safe". And then there are other risks on top of that - liquidity, reinvestment, etc.
    - dragonwriter 8y ago
      > You're acting as if default risk is the only relevant risk to creditors. No, I'm correctly characterizing inflation risk, which—by definition—does not involve losing money you had or anticipated. > You can't just wish it away by saying it's "why dollars are safe". No, the perceived lack of significant actual inflation risk is why dollars are considered safe, not the risk category itself.
lisper 8y ago
> sometimes they're even called risk free They may be called that, but they aren't. There are at least two risks associated with U.S. government bonds: 1. Inflation can exceed the interest rate on the bond and cause it to lose value when measured in actual purchasing power 2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money (To be fair, #1 is a risk associated with any bond. #2 is peculiar to U.S. government bonds.)
- gruez 8y ago
  > #2 is peculiar to U.S. government bonds.) not really, with private bonds it's replaced with the risk of the company defaulting or declaring bankruptcy.
- dqpb 8y ago
  Every investment carries risk in the form of opportunity cost.
- joshuamorton 8y ago
  >2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money This risk is likely also going to be true for the Dollar, so bonds don't carry any more risk than USD in this regard.
  - dragonwriter 8y ago
    > >2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money > This risk is likely also going to be true for the Dollar It can't be, because it doesn't apply to the currency, which while it is structurally created by creation of debt is not a debt the government is obligated to pay and on which it can fail and default. > so bonds don't carry any more risk than USD in this regard Even if there was a default risk in the dollar, bonds necessarily have more risk since they are fully exposed to every risk to the currency they are denominated in and also their own default risk, which even if the currency had such a risk would sit on top of it.
listenallyall 8y ago
>> Here's a simple example for explaining what this means This was not simple, nor did you explain what this means
- CamelCaseName 8y ago
  I found the example to be very clear. What exactly are you confused about? Here is the summary from the GP. >[An inverted yield curve] 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.
  - listenallyall 8y ago
    A simple example is 3 or 4 sentences, not 5 paragraphs. He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation?
    - toomanyrichies 8y ago
      > A simple example is 3 or 4 sentences, not 5 paragraphs. Where is that rule written? Where did those particular numbers come from? > He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation? You want the answer trimmed down to 3 or 4 sentences, but you also want answers to multiple new questions. Which one would you rather have?
      - listenallyall 8y ago
        I don't want anything. I'm just holding the top comment to its author's own standards that he voluntarily stated in his first sentence.
posix_compliant 8y ago
From what you've said, it's my interpretation that if the 10 year interest rate falls below the 5 year interest rate, then it means that bond purchasers speculate that money in 10 years will have more purchasing power than money in 5 years. Is that interpretation correct?
- ves 8y ago
  ...money in five years in five further years. the idea is that you’re evaluated on your purchasing power ten years hence, but in one case you have to liquidate your position five years in and find another position with the same risk characteristics.

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.
  - tfehring 8y ago
    Not quite - see https://fred.stlouisfed.org/series/T10Y3M https://fred.stlouisfed.org/series/T10Y3M for reference. The grey areas are recessions, and values below 0 are inversions. To address the GP’s point, the relationship could be fabricated, but the data don’t indicate that that’s happening.
Kinnard 8y ago
This doesn't account for recessions before the creation of the Federal Reserve.
nickles 8y ago
> the US has never had a recession that wasn’t preceded by an inverted yield curve This is incorrect. Most recessions in the post WW2 period have been preceded by an inversion of the 3m/10y UST curve, but it did not precede a few recessions in the USA during the first half of the 20th century. [0] http://bonddad.blogspot.com/2011/07/yield-curve-and-pre-ww2-recessions.html http://bonddad.blogspot.com/2011/07/yield-curve-and-pre-ww2-...
sytelus 8y ago
When large number of people are betting there is recession, there will a recession simply because people are collectively contracting their consumption in anticipation.

phkahler 8y ago

I'm actually hoping the fed refuses to lower rates. Let things dip a little rather than try to regulate the economy so much. Them jerking around rates was part of the trigger for 2008. Long term I think rates need to be higher anyway. So here's to hoping the speculators are wrong!

deleted 8y ago
[deleted]
JamesBarney 8y ago
Why do you think rates need to be higher? Inflation has been to high or unemployment has been too low? And I've never heard anyone say the fed caused the 2008 recession. It's pretty much universally agreed upon it was finance blowing up.
- mindslight 8y ago
  Inflation has been way too high. Not uniformly, but chiefly housing where new money is introduced into the consumer realm. In an inflation-neutral environment, one would expect the prices of manufactured goods to be trending slowly downwards. After all, producing something less expensively is exactly what economic competition leads to.
  - irq11 8y ago
    Housing, startups, art, cars, watches...pretty much everything collectible or rare has seen its value skyrocket since the great recession. The big pool of money has been sloshing between asset classes for a while now, but it doesn’t get reflected in inflation metrics.
    - JamesBarney 8y ago
      I think this is a combination of low interest rates making the opportunity cost of owning collectibles much lower and rising inequality driving up the purchasing power of collectors.

bobcostas55 8y ago

>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. This is absolutely not the reason they're considered low risk. If the USG tried to repay its debts by printing money, debtholders uninsured against inflation would lose tons of money. The expectation that they're _not_ going to print money to repay debt is part of why it's so safe.

dragonwriter 8y ago
> If the USG tried to repay its debts by printing money, debtholders uninsured against inflation would lose tons of money. No, they'd lose anticipated value of the debt repayment compared to other goods and services if the gov did that without other compensatory policy, but get all the money they expected. > The expectation that they're _not_ going to print money to repay debt is part of why it's so safe. You are confusing “why dollars are safe” with “why US government debt is safe”. The expectation that the money supply will be managed, in total, for stability and reasonably low inflation is why dollars are safe. (The expectation of not monetizing the debt, to the extent it is relevant at all, is relevant here.) The expectation that the US government will not in any case default is why, among dollar-denominated instruments, US government debt is considered almost as safe as actual dollars.
- bobcostas55 8y ago
  You're acting as if default risk is the only relevant risk to creditors. Inflation risk is just as real. You can't just wish it away by saying it's "why dollars are safe". And then there are other risks on top of that - liquidity, reinvestment, etc.
  - dragonwriter 8y ago
    > You're acting as if default risk is the only relevant risk to creditors. No, I'm correctly characterizing inflation risk, which—by definition—does not involve losing money you had or anticipated. > You can't just wish it away by saying it's "why dollars are safe". No, the perceived lack of significant actual inflation risk is why dollars are considered safe, not the risk category itself.

lisper 8y ago

> sometimes they're even called risk free They may be called that, but they aren't. There are at least two risks associated with U.S. government bonds: 1. Inflation can exceed the interest rate on the bond and cause it to lose value when measured in actual purchasing power 2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money (To be fair, #1 is a risk associated with any bond. #2 is peculiar to U.S. government bonds.)

gruez 8y ago
> #2 is peculiar to U.S. government bonds.) not really, with private bonds it's replaced with the risk of the company defaulting or declaring bankruptcy.
dqpb 8y ago
Every investment carries risk in the form of opportunity cost.
joshuamorton 8y ago
>2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money This risk is likely also going to be true for the Dollar, so bonds don't carry any more risk than USD in this regard.
- dragonwriter 8y ago
  > >2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money > This risk is likely also going to be true for the Dollar It can't be, because it doesn't apply to the currency, which while it is structurally created by creation of debt is not a debt the government is obligated to pay and on which it can fail and default. > so bonds don't carry any more risk than USD in this regard Even if there was a default risk in the dollar, bonds necessarily have more risk since they are fully exposed to every risk to the currency they are denominated in and also their own default risk, which even if the currency had such a risk would sit on top of it.

listenallyall 8y ago

>> Here's a simple example for explaining what this means This was not simple, nor did you explain what this means

CamelCaseName 8y ago
I found the example to be very clear. What exactly are you confused about? Here is the summary from the GP. >[An inverted yield curve] 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.
- listenallyall 8y ago
  A simple example is 3 or 4 sentences, not 5 paragraphs. He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation?
  - toomanyrichies 8y ago
    > A simple example is 3 or 4 sentences, not 5 paragraphs. Where is that rule written? Where did those particular numbers come from? > He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation? You want the answer trimmed down to 3 or 4 sentences, but you also want answers to multiple new questions. Which one would you rather have?
    - listenallyall 8y ago
      I don't want anything. I'm just holding the top comment to its author's own standards that he voluntarily stated in his first sentence.

posix_compliant 8y ago

From what you've said, it's my interpretation that if the 10 year interest rate falls below the 5 year interest rate, then it means that bond purchasers speculate that money in 10 years will have more purchasing power than money in 5 years. Is that interpretation correct?

ves 8y ago
...money in five years in five further years. the idea is that you’re evaluated on your purchasing power ten years hence, but in one case you have to liquidate your position five years in and find another position with the same risk characteristics.