6 ms·

10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity

bradleyjg 7y ago
Given that every reliable trading signal inevitably gets arb’ed away why does everyone and his brother think this one must be rock solid?
- tntn 7y ago
  There's no better way to get a recession than to have everyone acting like there is going to be a recession. Yield inversion indicates the market is starting to think there is going to be one.
- vasilipupkin 7y ago
  This isn’t a trading signal, so you can’t arb it away.
- panarky 7y ago
  Short-term trading signals are frequently arb'ed away. But long-term structural patterns take far more capital to arbitrage and your position can be deep under water for years at a time. There just isn't that much patient capital.
  - nickles 7y ago
    > Short-term trading signals are systematically arb'ed away This isn't necessarily true. There are demonstrable, persistent calendar effects that can be reliably traded. Such trading can be thought of as a service being provided to market participants for a fee (e.g. balance sheet as a service).
    - lbotos 7y ago
      Examples? I believe you, just wanna think about this more.
      - nickles 7y ago
        I apologize for not being more specific, but that was deliberate. Please trust that there are very real phenomena that can be monetized. One example of a calendar effect that is likely not easily monetized is the 'Christmas effect' for VIX [0] due to decreases in trading activity. [0] https://jai.iijournals.com/content/20/2/65 https://jai.iijournals.com/content/20/2/65
- nickles 7y ago
  This signal is typically only indicative in the United States, as the Fed doesn't officially factor it into the decision making process. Other central banks consider it, so it does not seem to have the same predictive power. The treasury market reflects demand for 'risk-free' securities, which functionally serve as bank accounts for corporate entities without access to bank reserves on the Fed's balance sheet. When market participants expect rate cuts in the future, long term assets with a locked in yield become more attractive to hold relative to short tenors, as the short dated treasuries need to be rolled more frequently. Additionally, it may be that the curve inversion itself causes greater expense in short term funding (e.g. overnight), leading to potential contractions in economic activity.
- inflatableDodo 7y ago
  Someone please correct me if I have misunderstood anything here, but having a better rate for a bond that matures after 3 months, than for one that matures after 10 years, is definitely a bit odd.
  - jerrybee 7y ago
    It’s not odd if you think that interest rates will go down in the future. If you believe that then you should buy longer term bonds to lock in the higher rate now.
  - nickles 7y ago
    If you purchase a 3m treasury bill, you will have to roll your capital into another in 3 months. If you expect the Fed to cut rates in the interim, you will receive a lower yield on that bill. The discount on the bill helps compensate for that risk.
    - inflatableDodo 7y ago
      I suppose the fed could cut rates in the next three months, however currently they are mostly making noises about not moving it up or down. Other people's current predictions on this are all over the place and seem more dependent on what each author would prefer than neccessarily any reality. I can find mainstream articles telling me why the fed must move rates up and others that insist that they must move them down. This makes me suspect that the fed is probably going to remain roughly fixed, at least for a bit.
      - nickles 7y ago
        > Other people's current predictions on this are all over the place and seem more dependent on what each author would prefer than neccessarily any reality. Expectations of Fed rate hikes and cuts are reflected in the fed funds futures market, where participants estimate future values of the fed funds rate. Currently, the market implies a 94% chance of at least one rate cut by December [0]. [0] https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/ https://www.cmegroup.com/trading/interest-rates/countdown-to...
- lordnacho 7y ago
  Ex quant trader here. There's no arbitrage in the strict sense, that's clear. But there's none in the statistical sense, either. Yield curve inversion doesn't happen all that often, how are you going to confidently bet that what happened the last few times will happen again this time, given that n is so low and there's always the issue of regime change?
  - bradleyjg 7y ago
    Yes, that’s exactly why pundits shouldn’t be so confident. All the same reasons for uncertainty apply to investors and pundits alike—-but confidence in punditry garners little risk.
yasp 7y ago
Isn't it the 10Y-2Y which is the famous recession signal?
- nickles 7y ago
  No, 3m-10Y is the best recession signal for the United States. [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...
  - ianai 7y ago
    They’re graphing 10y-3mo here. Is that what you mean? Minus is not commutative.
    - nitrogen 7y ago
      Swapping the order of a subtraction just flips the result vertically, doesn't it? So you'd see the same trend and just have to look at it the other way.
    - nickles 7y ago
      > They’re graphing 10y-3mo here. Is that what you mean? Minus is not commutative. The synthetic instrument 3m-10y is referred to as a 'curve'. It can be denoted 3m-10y. Convention is such that the value of a curve is long dated tenor minus short dated tenor.
      - FabHK 7y ago
        Just to expand on this: One names the spread by denoting the two instruments, by convention first the short dated, then the long dated (for example, 2y/10y or 3m/10y or indeed 3m-10y, where the '-' is a hyphen). One computes the spread by subtracting the short dated yield from the long dated one (ie, 10y - 3m, where the '-' is a minus).
        7y ago
tyrust 7y ago
Without any sort of annotation or explanation this post isn't really valuable. That said, with annotation and explanation it would only be incrementally more valuable. TA is like reading tea leaves.
- FabHK 7y ago
  This is not technical analysis, this is a macroeconomic indicator. No voodoo here.
  - tyrust 7y ago
    Call it what you want, it's still people trying to make predictions based on limited signal. As the top comment says, this alone isn't necessarily meaningful.
cs702 7y ago
For context, this has happened before, prior to recessions, as shown here: https://fred.stlouisfed.org/graph/?g=mtiz https://fred.stlouisfed.org/graph/?g=mtiz However, this is the first time this kind of yield inversion has occurred right after the Fed announced plans to stop reducing its balance sheet, which grew to unprecedented levels in response to the financial crisis. You can see the enormous impact that the Fed's balance sheet growth had on the monetary base here: https://fred.stlouisfed.org/graph/?g=lIdk https://fred.stlouisfed.org/graph/?g=lIdk Until recently, the Fed had been reducing its balance sheet by up to $54B/month; it announced plans to stop.[a][b] How and to what degree has this impacted yields? As additional context, consider that the yield inversion has occurred during a rise in import tariffs, trading restrictions, and public threats between the US and China (and now Mexico too). So far, the economic impact of these trading spats on the US economy has been small.[c] Could the recent yield inversion be caused more by a global flight to safety. in conjunction to the Fed's actions, than the actual risk of a US recession? Is it even possible to answer these questions with certainty? I'd be leery of any predictions for the US economy based solely on this recent inversion of the yield curve. [a] https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm https://www.federalreserve.gov/monetarypolicy/bst_recenttren... [b] https://www.reuters.com/article/us-usa-fed-balancesheet/fed-announces-plan-to-end-balance-sheet-runoff-in-september-idUSKCN1R12QA https://www.reuters.com/article/us-usa-fed-balancesheet/fed-... [c] https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-china-economy.html https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-...
- nickles 7y ago
  > How and to what degree has this impacted yields? Is it even possible to answer this question with certainty? To reduce its balance sheet, the Fed has rolled down assets, allowing them to mature. By choosing to not reinvest the principal from these matured assets, they reduce the size of the balance sheet. My understanding is that the reinvestment occurs in longer dated securities, which would put flattening pressure on the curve. Estimates indicate a reduction of these purchases would raise 10y yields 40-60bps [0]. All other things being equal, this would lead to steepening of the yield curve. > I'd be leery of any predictions of recession in the US based solely on yield inversion. Not all yield curve inversions have preceded recessions, but almost all recent recessions have been preceded by yield curve inversions. Yield curve inversions lasting 10 days or longer tend to have more predictive power. The inversion in March did not last that long, for example. On average, a recession follows 14 months after an inversion [1]. [0] https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc35c https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc... [1] https://www.advisorperspectives.com/articles/2019/04/01/a-historical-perspective-on-inverted-yield-curves https://www.advisorperspectives.com/articles/2019/04/01/a-hi...

Given that every reliable trading signal inevitably gets arb’ed away why does everyone and his brother think this one must be rock solid?

tntn 7y ago
There's no better way to get a recession than to have everyone acting like there is going to be a recession. Yield inversion indicates the market is starting to think there is going to be one.
vasilipupkin 7y ago
This isn’t a trading signal, so you can’t arb it away.
panarky 7y ago
Short-term trading signals are frequently arb'ed away. But long-term structural patterns take far more capital to arbitrage and your position can be deep under water for years at a time. There just isn't that much patient capital.
- nickles 7y ago
  > Short-term trading signals are systematically arb'ed away This isn't necessarily true. There are demonstrable, persistent calendar effects that can be reliably traded. Such trading can be thought of as a service being provided to market participants for a fee (e.g. balance sheet as a service).
  - lbotos 7y ago
    Examples? I believe you, just wanna think about this more.
    - nickles 7y ago
      I apologize for not being more specific, but that was deliberate. Please trust that there are very real phenomena that can be monetized. One example of a calendar effect that is likely not easily monetized is the 'Christmas effect' for VIX [0] due to decreases in trading activity. [0] https://jai.iijournals.com/content/20/2/65 https://jai.iijournals.com/content/20/2/65
nickles 7y ago
This signal is typically only indicative in the United States, as the Fed doesn't officially factor it into the decision making process. Other central banks consider it, so it does not seem to have the same predictive power. The treasury market reflects demand for 'risk-free' securities, which functionally serve as bank accounts for corporate entities without access to bank reserves on the Fed's balance sheet. When market participants expect rate cuts in the future, long term assets with a locked in yield become more attractive to hold relative to short tenors, as the short dated treasuries need to be rolled more frequently. Additionally, it may be that the curve inversion itself causes greater expense in short term funding (e.g. overnight), leading to potential contractions in economic activity.
inflatableDodo 7y ago
Someone please correct me if I have misunderstood anything here, but having a better rate for a bond that matures after 3 months, than for one that matures after 10 years, is definitely a bit odd.
- jerrybee 7y ago
  It’s not odd if you think that interest rates will go down in the future. If you believe that then you should buy longer term bonds to lock in the higher rate now.
- nickles 7y ago
  If you purchase a 3m treasury bill, you will have to roll your capital into another in 3 months. If you expect the Fed to cut rates in the interim, you will receive a lower yield on that bill. The discount on the bill helps compensate for that risk.
  - inflatableDodo 7y ago
    I suppose the fed could cut rates in the next three months, however currently they are mostly making noises about not moving it up or down. Other people's current predictions on this are all over the place and seem more dependent on what each author would prefer than neccessarily any reality. I can find mainstream articles telling me why the fed must move rates up and others that insist that they must move them down. This makes me suspect that the fed is probably going to remain roughly fixed, at least for a bit.
    - nickles 7y ago
      > Other people's current predictions on this are all over the place and seem more dependent on what each author would prefer than neccessarily any reality. Expectations of Fed rate hikes and cuts are reflected in the fed funds futures market, where participants estimate future values of the fed funds rate. Currently, the market implies a 94% chance of at least one rate cut by December [0]. [0] https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/ https://www.cmegroup.com/trading/interest-rates/countdown-to...
lordnacho 7y ago
Ex quant trader here. There's no arbitrage in the strict sense, that's clear. But there's none in the statistical sense, either. Yield curve inversion doesn't happen all that often, how are you going to confidently bet that what happened the last few times will happen again this time, given that n is so low and there's always the issue of regime change?
- bradleyjg 7y ago
  Yes, that’s exactly why pundits shouldn’t be so confident. All the same reasons for uncertainty apply to investors and pundits alike—-but confidence in punditry garners little risk.

yasp 7y ago

Isn't it the 10Y-2Y which is the famous recession signal?

nickles 7y ago
No, 3m-10Y is the best recession signal for the United States. [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...
- ianai 7y ago
  They’re graphing 10y-3mo here. Is that what you mean? Minus is not commutative.
  - nitrogen 7y ago
    Swapping the order of a subtraction just flips the result vertically, doesn't it? So you'd see the same trend and just have to look at it the other way.
  - nickles 7y ago
    > They’re graphing 10y-3mo here. Is that what you mean? Minus is not commutative. The synthetic instrument 3m-10y is referred to as a 'curve'. It can be denoted 3m-10y. Convention is such that the value of a curve is long dated tenor minus short dated tenor.
    - FabHK 7y ago
      Just to expand on this: One names the spread by denoting the two instruments, by convention first the short dated, then the long dated (for example, 2y/10y or 3m/10y or indeed 3m-10y, where the '-' is a hyphen). One computes the spread by subtracting the short dated yield from the long dated one (ie, 10y - 3m, where the '-' is a minus).
      - 7y ago

tyrust 7y ago

Without any sort of annotation or explanation this post isn't really valuable. That said, with annotation and explanation it would only be incrementally more valuable. TA is like reading tea leaves.

FabHK 7y ago
This is not technical analysis, this is a macroeconomic indicator. No voodoo here.
- tyrust 7y ago
  Call it what you want, it's still people trying to make predictions based on limited signal. As the top comment says, this alone isn't necessarily meaningful.

cs702 7y ago

For context, this has happened before, prior to recessions, as shown here: https://fred.stlouisfed.org/graph/?g=mtiz https://fred.stlouisfed.org/graph/?g=mtiz However, this is the first time this kind of yield inversion has occurred right after the Fed announced plans to stop reducing its balance sheet, which grew to unprecedented levels in response to the financial crisis. You can see the enormous impact that the Fed's balance sheet growth had on the monetary base here: https://fred.stlouisfed.org/graph/?g=lIdk https://fred.stlouisfed.org/graph/?g=lIdk Until recently, the Fed had been reducing its balance sheet by up to $54B/month; it announced plans to stop.[a][b] How and to what degree has this impacted yields? As additional context, consider that the yield inversion has occurred during a rise in import tariffs, trading restrictions, and public threats between the US and China (and now Mexico too). So far, the economic impact of these trading spats on the US economy has been small.[c] Could the recent yield inversion be caused more by a global flight to safety. in conjunction to the Fed's actions, than the actual risk of a US recession? Is it even possible to answer these questions with certainty? I'd be leery of any predictions for the US economy based solely on this recent inversion of the yield curve. [a] https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm https://www.federalreserve.gov/monetarypolicy/bst_recenttren... [b] https://www.reuters.com/article/us-usa-fed-balancesheet/fed-announces-plan-to-end-balance-sheet-runoff-in-september-idUSKCN1R12QA https://www.reuters.com/article/us-usa-fed-balancesheet/fed-... [c] https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-china-economy.html https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-...

nickles 7y ago
> How and to what degree has this impacted yields? Is it even possible to answer this question with certainty? To reduce its balance sheet, the Fed has rolled down assets, allowing them to mature. By choosing to not reinvest the principal from these matured assets, they reduce the size of the balance sheet. My understanding is that the reinvestment occurs in longer dated securities, which would put flattening pressure on the curve. Estimates indicate a reduction of these purchases would raise 10y yields 40-60bps [0]. All other things being equal, this would lead to steepening of the yield curve. > I'd be leery of any predictions of recession in the US based solely on yield inversion. Not all yield curve inversions have preceded recessions, but almost all recent recessions have been preceded by yield curve inversions. Yield curve inversions lasting 10 days or longer tend to have more predictive power. The inversion in March did not last that long, for example. On average, a recession follows 14 months after an inversion [1]. [0] https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc35c https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc... [1] https://www.advisorperspectives.com/articles/2019/04/01/a-historical-perspective-on-inverted-yield-curves https://www.advisorperspectives.com/articles/2019/04/01/a-hi...