4 ms·

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.

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.