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I'm surprised that everyone blindly cites the inverted yield curve as a recession indicator without considering the "why". Seriously, if you were to ask ten peo
by dkrich 7y ago
I'm surprised that everyone blindly cites the inverted yield curve as a recession indicator without considering the "why". Seriously, if you were to ask ten people why an inverted curve predicts recession, you'd get ten completely different answers.
I personally don't think this is necessarily the inversion that is going to be predictive of a recession because the inversion is occurring at the long end (the 10/30 years spiking as opposed to the 3 month/2 year selling off). I think the short end is far more important than the long end because the short end tells you about monetary conditions in the economy. If the short end yields start moving up, that means that it's going to become more expensive to borrow money so spending and capex contracts, which is what can bring on a recession. Even that depends on the degree to which monetary conditions deteriorate.
Why are long bonds spiking? Because other central banks around the world are even more dovish than the US Fed, so money that is looking for long-term safe haven investments is coming aggressively into US long bonds.
Take a look at three month commercial paper rates, which are actually in a major downtrend (not surprising given Fed policy): https://ycharts.com/indicators/3_month_aa_financial_commercial_paper_rate https://ycharts.com/indicators/3_month_aa_financial_commerci...
Three month commercial paper rates represent the cost at which businesses are currently borrowing for short-term expenses on the open market. That cost is going down, too. I take that to mean monetary conditions are very good in the sense that there is no shortage of money floating around the economy looking for a return. Without some major fundamental change in economic conditions I don't see how equities can be expected to drop a whole lot from here. I think this is a blow off the top for rates that is going to be short-lived, especially if other central banks start tightening policy which nobody seems to consider a possibility. But if inflation starts creeping up, then they will likely start raising rates or keeping them where they are. Ironically, when central banks raise rates that is usually an extremely bearish indicator. It's a bit puzzling to me that everyone seems convinced that lower rates are bearish.
Also, I can't think of a time when literally everyone focused on a single indicator at the same time, used said indicator as a predictive tool, and were proven correct. That's just not how markets work. People get scared and excited at the worst times tactically.
- xivzgrev 7y agoI agree. For the two recessions I’ve lived through, we didn’t arrive at them with everyone well aware it was going to happen. They snuck up and took the country by surprise. The tech bubble burst, and the real estate subprime bubble burst. We may go into a slump because everyone is expecting a splump to happen because it’s been 10 or so years of a bull run. But I don’t see a full-on recession without a large bubble bursting somewhere in the economy, causing a panic.
- 3JPLW 7y agoThis is what I've been seeing, too. If everyone is expecting a recession, then the recession gets "priced into" the current valuations. The big trouble comes if the expectations/pricings are off in some sector.
- WarDores 7y agoThe question is, what is the bubble? I'd argue the entire stock market is the bubble right now, with boomers throwing everything they have into the market to get some of that free money before they retire. Once they start pulling back it's going to be a sad day. Right now US household "wealth" is sitting at >500% of GDP. That's not sustainable.
- pushtheenvelope 7y agoWhy is it not sustainable that household wealth is > 500% of GDP? In the parlance of company finances, GDP is like revenue and wealth is the valuation representing the present value of all future profits. So, it seems fine to me that the present value of future profits of the US is 5x the current revenue. I'm seeking to understand where this analogy may break down. Thanks :)
- WarDores 7y agoTraditionally, anything above ~350% has indicated a bubble. With the housing bubble, we saw a peak of 473%, and the dot-com bubble was 429% at its peak. Essentially, yes, wealth will be a multiple of GDP, but the multiple has been fairly constant historically, and it's diverging rapidly now. So either we're in an era where assets are significantly more valuable (and I'm not sure there's a good case for that given the multiplier), or we're in an asset bubble.
- PaulHoule 7y agoFor one thing, inverted yield curves are bad for banks and for investors who do the same thing as banks. That is, the main thing banks do is borrow short-term (demand deposits, 2-year CD) and lend long-term (5 year car loan, 30 year fixed mortgage.) Conventionally long-term interest rates are more than short-term interest rates so you can make money this way. With an inverted yield curve you can't make money that way. Since banks are important to the flow of capital in the economy, something that hurts the banks can hurt the wider economy.