
U.S. Treasury Yield Curve Inverts for First Time Since 2007 - ramoz
https://www.bloomberg.com/news/articles/2019-03-22/u-s-treasury-yield-curve-inverts-for-first-time-since-2007
======
spchampion2
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.

~~~
lisper
> 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.)

~~~
joshuamorton
>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
> >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.

~~~
Phlarp
Except that if/when political dysfunction does cause a default on the bonds,
the currency gets its legs chopped out from under it.

~~~
buttcoinslol
Which makes it exceptionally unlikely to happen..

Although Brexit happened, so never say never I guess

------
apo
> While the 3-month to 10-year spread “has a relatively decent track record of
> predicting recessions, it suffers from a timing problem,” said TD Securities
> U.S. rates strategist Gennadiy Goldberg. “Its inversion can suggest a
> recession occurred six months ago or will occur two years from now.”

Not just "relatively decent," but perfect over the last seven recessions at
least. When the 3-month treasury yields more than the 10-year treasury, the
economy has been in recession within two years 7/7 times.

[https://seekingalpha.com/article/4250287-fully-inverted-
yiel...](https://seekingalpha.com/article/4250287-fully-inverted-yield-curve-
consequently-recession-coming-doorstep-soon)

There are a lot of leading economic indicators, but this one beats them all in
terms of reliability.

There's one complicating factor that I don't see getting the attention it
deserves. Unlike previous cycles, the Fed has been actively manipulating long-
term yields for over a decade. That used to be taboo, but not anymore. The Fed
holds trillions of dollars of long-term treasuries, accumulated under its QE/X
programs.

The ownership of that debt by the Fed puts downward pressure on long-term
yields. Recently, the Fed started allowing its long bonds to mature through
its "quantitative tightening" (QT) program. That pressure (which really ramped
up a few months ago) may have temporarily pumped up yields, and in so doing
delayed a yield curve inversion signal. The status going forward of QT and the
Fed's gargantuan balance sheet is anybody's guess. My bet is the Fed is done
with QT until at least after the 2020 election. If things really start going
south, watch for the Fed to begin buying stocks directly like the Bank of
Japan has been doing for years. That and negative-yielding treasuries.

Either way, this is unprecedented territory. Signals could be quite confounded
for the foreseeable future - which means policy makers are winging it. They
almost certainly will make the wrong decisions.

~~~
sytelus
As an investor, I find this rather a good thing. If I have to constantly
afraid of recession then I would tend to just wait and sit on cash. If Fed is
doing all these interventions including directly buying stock with their
trillion dollar war chest + printing press then may be recession can be
avoided or at least softened out. I also worry that recession may happen just
because people are expecting it to happen even though economy is pretty sound.
In that case, Fed intervention can avoid things falling fast just for short
time and collective fear can be subsided back to sanity.

------
whb07
Most of the commentary on the signaling of an inverted yield curve is all
parroted by everyone else as “ominous”. Catherine Wood is the only person I’ve
seen to go against the grain on this one [0].

Essentially, she notes that the yield curve has been inverted roughly 50% of
the time in the late 19th century and early 20th century. Furthermore, during
the times it was inverted, it marked periods of strong growth!

It’s an interesting take as everyone else conveniently (more like lazy) are
not doing the research and going back as far back as late 18th century. Her
point of view is contrarian and refreshingly unique!

[0] [https://www.cnbc.com/2018/12/04/the-economy-will-surprise-
to...](https://www.cnbc.com/2018/12/04/the-economy-will-surprise-to-the-high-
next-year-arks-catherine-wood.html)

~~~
dragonwriter
> Essentially, she notes that the yield curve has been inverted roughly 50% of
> the time in the late 19th century and early 20th century.

Actually, she says specifically 1800-1929, which is an interesting choice
because AFAICT the “3-month" security (the 13-week T-bill) referenced when
discussing the 3m/10y inversion (the one discussed here as a key indicator)
was first regularly issued in 1929. [0]

The behavior of the markets when either or both of the instruments in the
analysis were not regularly issued is obviously not comparable. (Further, when
they aren't both regularly issued, assessing how much of the time an inversion
was in effect is, at best, creative extrapolation, and more likely outright
fiction.)

> It’s an interesting take as everyone else conveniently (more like lazy) are
> not doing the research and going back as far back as late 18th century.

So lazy of everyone else to only study a measure as far back as the basic
premises of using the measure are valid and the components that make it up
actually exist.

[0]
[https://www.treasurydirect.gov/indiv/research/history/histmk...](https://www.treasurydirect.gov/indiv/research/history/histmkt/histmkt_bills.htm)

~~~
dnautics
wouldn't the motion of the yield curve in that era be very different given
that the dollar was long-term noninflationary?

if you expect the dollar to deflate in the long term, you might be OK
accepting a lower long term yield.

------
potatofarmer45
A lot of the people in Finance are surprisingly superstitious. I had a boss
once who would not conduct trades if he saw a totally unrelated bad omen.

The treasury yield curve is a measure of expectations. It's a market marker
that is the result of traders and reflects the overall view of the economy.

Having said that, it's also taken on a mythical status where now that it has
inverted, people will start planning for a recession which may in turn lead to
happening much sooner/if at all. It's a self fulfilling prophecy in a way
where the expectation of a recession leads you act in a way that leads to that
outcome.

~~~
Invictus0
Is it that surprising though? For a group of people that believes they can
predict the future?

------
wk0
notably, the 2 & 10 year has not yet inverted

[https://fred.stlouisfed.org/series/T10Y2Y](https://fred.stlouisfed.org/series/T10Y2Y)

~~~
nodesocket
In December it was the 3 and 5 year which inverted, and today it was the 3
month and 10 year. Typically I’ve understood the biggest one to watch is the 2
and 10 year though.

------
mattmaroon
I'm not sure that the yield curve isn't us being fooled by randomness.
Everyone is looking at every metric for predictive ability. The odds that one
of them went 7/7 have to approach 1.

~~~
all_blue_chucks
Yield curve inversion is something like like 15/7, actually.

------
buzzdenver
I am surprised this is not happening more frequently. An inversion between the
1 and 5 year bonds just means that the expected average yield for each of the
next 5 years is less than the yield for next year. Statistically that should
be the case 50% of the time. Treasure bonds are liquid, so buying a 5 year one
does not mean that you have to hold it to maturity.

Somebody tell me where I'm wrong.

~~~
nickles
There are a few factors that cause one to expect a monotonically increasing,
concave yield curve [0].

Firstly, one must consider the term premium [1]. In short, you expect to be
compensated more for lending money for a longer period of time. Consider
lending money for two years. You could lend your money in two single year-long
increments, in which case you would compound your gains from the first year
when you lend out the second year. If you lend in a single, two year-long
commitment, you rationally expect, all else being equal, to earn as much as
you would have by lending as described previously. This drives the general
upwards slope (or contango) of the yield curve.

Next, consider a credit component. When you lend someone money, how likely is
it that you are paid back? If you expect there is default risk, you factor
that into the interest rate you demand. As the tenor of the bond increases,
the risk of default increases. However, the extra interest you demand for
credit risk also decreases as time goes out. Why? What are the chances that
someone defaults on a loan between 5 and 10 years? Probably greater than the
risk that the party defaults between 10 and 15 years. This drives the
concavity of the yield curve.

Finally, the movement in the curve is driven by expectations of future
interest rates, as determined by Federal Reserve policy. Fed typically acts at
the short end of the curve. In its tool chest, fed can manipulate rates like
the fed funds rate, IOER, and ON REPO. As the economy improves, fed will raise
rates. When economic outlook declines, fed will lower rates. If you expect
that rates will be higher in the future, you will demand higher yields for
longer dated bonds, since your invested money will earn less of a premium to
interest rates in the future relative to where you invested today. On the flip
side, if you expect interest rates to decline, you will want to lock in your
money now, so you purchase longer dated bonds, since you do not expect to be
able to get as high a yield in the future. This action at the long end of the
curve, coupled with fed policy at the short end, ultimately drives yield curve
fluctuations.

[0] [https://obliviousinvestor.com/wp-
content/uploads/2012/07/yie...](https://obliviousinvestor.com/wp-
content/uploads/2012/07/yieldcurves.png)

[1] [https://www.bloomberg.com/news/articles/2017-10-30/what-
s-a-...](https://www.bloomberg.com/news/articles/2017-10-30/what-s-a-term-
premium-and-where-did-mine-go-quicktake-q-a)

------
aznpwnzor
Hmm for some reason I thought this was already the case actually.

I was looking at Ally CD rates a few weeks ago, and I saw an inversion there
and I just chalked that up to the CD rates being dependent on the yield curve.

Does it?

~~~
levthedev
There was a less extreme yield curve inversion a few months ago, which is
likely what you're referring to. But it wasn't so far reaching as the current
inversion, which puts the 1 year Treasury over the 10 year.

------
Varcht
What would it cost to make this happen?

------
ckdarby
Can someone explain what kind of impact this has?

~~~
defertoreptar
Apparently it has predicted the last seven recessions. People are using the
expression "self-fulfilling prophecy."

~~~
AnimalMuppet
It may have predicted ten out of the last seven recessions. That is, sometimes
the yield curve inverts and the recession doesn't happen. So it's not quite a
self-fulfilling prophesy - though it still may be a sometimes-self-fulfilling
prophesy...

~~~
dajohnson89
correct. we can't determine the usefulness of this statistic without a false
positive rate.

