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I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks. Put the 10 year in context: in Japan

I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks. Put the 10 year in context: in Japan and Germany and other stable countries yields are negative. So you have to pay to lend those countries money, because the central banks are pushing yields negative. But in the US you can actually get a modest (but real) return on the ten year, so it’s quite popular. This popularity has pushed the price lower and flattened the curve. And while recession may not be in the cards for the US in the next few years, the next ten years is a whole different story - so given the newfound dovishness of the Fed given European and Chinese weakness, it makes sense to lock in some yield in those ten year bonds now.

wilkystyle 8y ago
While I'm not saying you're wrong (and I'm not pretending to know enough to fully understand all the forces at play here), the article ends with the following statement that I find interesting, in light of your comment: > Every time the yield curve inverts there is a theory about why it doesn’t matter. The stock market rallies that often follow inversions further allay fears that it really is different. In the end, it almost always ends up not being different.
- nostromo 8y ago
  "almost always" Keep in mind this signal was only discovered in 1989. So we have a forward-looking success rate of three out of three recessions predicted within a year or two. 3/3 is great, of course, but it wasn't delivered on stone tablets from Mount Sinai. The strange thing about predictive economic indicators is they often stop being predictive once popularized. Why? For example, in 2000 and 2006/7 the Fed raised interest rates aggressively even after the inversion. However, we know that the current Fed is looking at the curve, and has become much more dovish since the inversion. So it's entirely possible that it's predictive ability will be diminished precisely because policy makers are paying attention to it.
  - pmart123 8y ago
    In the current circumstance, one argument is that the Fed overreacted in raising short-term rates, making those rates artificially high. I suppose there is some support for this without looking too deeply into it as the Fed now is unwinding QE. Unwinding QE still is "tightening" monetary policy. My guess is that the Fed believes that by lowering its portfolio's duration is a more effective way to raise longer-term yields to prevent the yield curve from becoming more inverted. I'm not a monetary expert, but I suppose you could say this time is different due to QE/QT, or you could stick with how the market typically reacts after the yield curve inverts.
nickles 8y ago
> I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks. 3m/10y curve inversion has proven to be a reasonable signal for upcoming recession in the USA for the post WW2 period [0]. If the Federal Reserve were to factor this signal into its decision making processes (as ECB and BoJ do), its predictive power would likely decline (can't recall the episode of the podcast Macro Musings at present for citation). > Put the 10 year in context: in Japan and Germany and other stable countries yields are negative. So you have to pay to lend those countries money, because the central banks are pushing yields negative. You can earn positive (nominal) yields on JGBs [1] and Bunds [2], so not all yields are negative. > But in the US you can actually get a modest (but real) return on the ten year, so it’s quite popular. This popularity has pushed the price lower. You're comparing outright duration to curve risk. These are distinct. When discussing curve inversions, you are comparing the spread between two points on a curve, precisely to eliminate any parallel shift component. In this case, the comparison is between a 3m investing period and a 10y investing period. > And while recession may not be in the cards for the US in the next few years, ten years is a whole different story On what basis do you assert that recession isn't possible in the US over the next few years? Fed funds futures currently imply a 63% chance of easing by the end of 2019 [3], indicating expectations of deteriorating economic conditions. [0] https://www.frbsf.org/economic-research/publications/economic-letter/2018/august/information-in-yield-curve-about-future-recessions/ https://www.frbsf.org/economic-research/publications/economi... [1] https://www.bloomberg.com/markets/rates-bonds/government-bonds/japan https://www.bloomberg.com/markets/rates-bonds/government-bon... [2] https://www.bloomberg.com/markets/rates-bonds/government-bonds/germany https://www.bloomberg.com/markets/rates-bonds/government-bon... [3] https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/ https://www.cmegroup.com/trading/interest-rates/countdown-to...
defertoreptar 8y ago
Huh, you're right that European interest rates have done nothing but go down: https://tradingeconomics.com/euro-area/interest-rate https://tradingeconomics.com/euro-area/interest-rate. That could explain added demand on US long term rates, but as the article pointed out, people said the exact same thing in 2006.
cbayram 8y ago
Feels like capital from emerging markets is being reallocated into T-bills and co.
shostack 8y ago
What do we know about long term risk and consequences regarding countries operating with negative rates? Can they be considered healthy? Or is this a sign of longer term risk they face? What does that environment mean for Joe Consumer and their 401k?

wilkystyle 8y ago

While I'm not saying you're wrong (and I'm not pretending to know enough to fully understand all the forces at play here), the article ends with the following statement that I find interesting, in light of your comment: > Every time the yield curve inverts there is a theory about why it doesn’t matter. The stock market rallies that often follow inversions further allay fears that it really is different. In the end, it almost always ends up not being different.

nostromo 8y ago
"almost always" Keep in mind this signal was only discovered in 1989. So we have a forward-looking success rate of three out of three recessions predicted within a year or two. 3/3 is great, of course, but it wasn't delivered on stone tablets from Mount Sinai. The strange thing about predictive economic indicators is they often stop being predictive once popularized. Why? For example, in 2000 and 2006/7 the Fed raised interest rates aggressively even after the inversion. However, we know that the current Fed is looking at the curve, and has become much more dovish since the inversion. So it's entirely possible that it's predictive ability will be diminished precisely because policy makers are paying attention to it.
- pmart123 8y ago
  In the current circumstance, one argument is that the Fed overreacted in raising short-term rates, making those rates artificially high. I suppose there is some support for this without looking too deeply into it as the Fed now is unwinding QE. Unwinding QE still is "tightening" monetary policy. My guess is that the Fed believes that by lowering its portfolio's duration is a more effective way to raise longer-term yields to prevent the yield curve from becoming more inverted. I'm not a monetary expert, but I suppose you could say this time is different due to QE/QT, or you could stick with how the market typically reacts after the yield curve inverts.

nickles 8y ago

> I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks. 3m/10y curve inversion has proven to be a reasonable signal for upcoming recession in the USA for the post WW2 period [0]. If the Federal Reserve were to factor this signal into its decision making processes (as ECB and BoJ do), its predictive power would likely decline (can't recall the episode of the podcast Macro Musings at present for citation). > Put the 10 year in context: in Japan and Germany and other stable countries yields are negative. So you have to pay to lend those countries money, because the central banks are pushing yields negative. You can earn positive (nominal) yields on JGBs [1] and Bunds [2], so not all yields are negative. > But in the US you can actually get a modest (but real) return on the ten year, so it’s quite popular. This popularity has pushed the price lower. You're comparing outright duration to curve risk. These are distinct. When discussing curve inversions, you are comparing the spread between two points on a curve, precisely to eliminate any parallel shift component. In this case, the comparison is between a 3m investing period and a 10y investing period. > And while recession may not be in the cards for the US in the next few years, ten years is a whole different story On what basis do you assert that recession isn't possible in the US over the next few years? Fed funds futures currently imply a 63% chance of easing by the end of 2019 [3], indicating expectations of deteriorating economic conditions. [0] https://www.frbsf.org/economic-research/publications/economic-letter/2018/august/information-in-yield-curve-about-future-recessions/ https://www.frbsf.org/economic-research/publications/economi... [1] https://www.bloomberg.com/markets/rates-bonds/government-bonds/japan https://www.bloomberg.com/markets/rates-bonds/government-bon... [2] https://www.bloomberg.com/markets/rates-bonds/government-bonds/germany https://www.bloomberg.com/markets/rates-bonds/government-bon... [3] https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/ https://www.cmegroup.com/trading/interest-rates/countdown-to...

defertoreptar 8y ago

Huh, you're right that European interest rates have done nothing but go down: https://tradingeconomics.com/euro-area/interest-rate https://tradingeconomics.com/euro-area/interest-rate. That could explain added demand on US long term rates, but as the article pointed out, people said the exact same thing in 2006.

cbayram 8y ago

Feels like capital from emerging markets is being reallocated into T-bills and co.

shostack 8y ago

What do we know about long term risk and consequences regarding countries operating with negative rates? Can they be considered healthy? Or is this a sign of longer term risk they face? What does that environment mean for Joe Consumer and their 401k?