
Yield Curve Is More Inverted Than at This Point in Run-Up to Financial Crisis - Four_Star
https://thesoundingline.com/us-treasury-yield-curve-is-more-inverted-than-at-this-point-in-the-run-up-to-the-financial-crisis/
======
chadash
Simple explanation of what this means. Here are current yields on Treasury
Bonds (expressed as an annualized rate)[0]:

1 Mo - 2.47

2 Mo - 2.47

3 Mo - 2.46

6 Mo - 2.49

1 Yr - 2.41

2 Yr - 2.26

3 Yr - 2.19

5 Yr - 2.21

7 Yr - 2.32

10 Yr - 2.43

20 Yr - 2.68

30 Yr - 2.87

In normal times, rates are higher for longer terms. This makes sense: the
longer I tie up my money, the higher interest rate I'm going to want. However,
right now, the rates are mostly inverted. For example, I'd get a higher rate
on a bond with a lockup period of 6 months than I would on a bond with a
lockup period of 10 years.

Typically, this sort of thing precedes a recession. Bond market investors
think that a recession is coming, so they are willing to pay for longer term
bonds on the assumption that rates on these will go down in the future when
the federal reserve lowers rates (to stimulate the economy) and when people
flee the stock market generally in order to avoid risk.

[0] Source [https://www.treasury.gov/resource-center/data-chart-
center/i...](https://www.treasury.gov/resource-center/data-chart-
center/interest-rates/pages/textview.aspx?data=yield)

~~~
iambateman
Thanks for this.

Question: is there any rational reason an investor would invest in a 10-year
bond when they could get a better interest rate on a six month bond?

It seems like an inversion would result in near-zero long-term bond purchases.

~~~
cesarb
With a 10-year bond, the investor receives that interest rate over the whole
10 years. With a 6-month bond, the investor receives that interest rate only
over these 6 months, and then has to find another bond to buy. If all
available bonds then have a lower interest rate, the investor would have
received more for the 10-year bond.

(What might be confusing at first is that interest rates are usually
"annualized", that is, presented as if they were for a single whole year. You
won't actually receive 2.49% of what you paid for the 6-month bond; you'll
receive something like 1.24%, and you have to invest again for another 6
months to reach that 2.49%. If that investment is no longer available, you
might not be able to do that.)

~~~
stoddler
One can invest it again in a 6 month bond with the yield curve inverted
further. The decrease in rates would happen over a longer term than 6 months.
And also if the rates have decreased the prices would have increased for the
bond that is held.

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MR4D
This should be expected. Given rising FED rates over the last year+, as well
as QT (quantitative Tightening, which undoes the QE in place for nearly a
decade), these actions are - and this is key - _reducing the money supply_.

It is the reduction of money supply that causes deflation (and therefore lower
rates). Technically, a yield curve inversion is an expectation of lower rates
in the future, not necessarily lower growth.

This is actually extremely important, but widely misunderstood: You can have
growth with deflation (and likewise, recession with inflation).

To make that point clear, _a yield curve inversion is an expectation of
interest rates, not necessarily an expectation of lower growth._

I expect this will cause all sorts of arguments, but the math is clear. I'll
quote the Mises Institute [0] on this:

 _For instance, if the money supply increases by 5% and the quantity of goods
increases by 10%, prices will fall by 5%._

[0] - [https://mises.org/wire/central-banks-shouldnt-fight-
deflatio...](https://mises.org/wire/central-banks-shouldnt-fight-deflation)

~~~
MR4D
I left off one clarification: it _tends_ to be a good predictor of recessions,
but is not perfect. See the inversions for the last half of the 1960's at the
St. Louis Fed [0] as a counter-example.

[0] -
[https://fred.stlouisfed.org/graph/?g=nn5r](https://fred.stlouisfed.org/graph/?g=nn5r)

------
nostromo
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
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
"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
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.

------
the_watcher
The headline implies a claim that I don't see any support for: that degree of
yield curve inversion is related to likelihood of recession. While that seems
plausible, I've never seen analysis that being more inverted is a stronger
predictor than simply being inverted at all.

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jl2718
Traders think yields will drop. Yields drop because liquidity increases.
Liquidity increases because more people want to lend than borrow. A recession
lowers the demand for debt, so the price drops and the yields rise. To fight
the recession, the fed creates dollars and buys debt with them. The lower
supply of and increased demand for debt raises the price, which drops the
yield. But this would only happen if the fed was unable to control the
recession. Economic expansion also raises the demand for debt. Or it could be
the effect of international debt arbitrage. Or balance of trade.

Truly I have no idea what traders are thinking. And they could all be wrong.

All I know is that this is way more complicated than pattern recognition.

------
areoform
What can the average founder, employee, and person do in the face of this
news?

I understand that it’s scary, but what can we do to turn that fear into an
actionable checklist?

~~~
rossdavidh
For example, paying down debt would be a good idea. [sound of numerous
economists jumping up and down saying this would turn prediction of recession
into self-fulfilling prophecy] Also, holding off on any major new purchases
like houses or new cars. [sound of foresaid economists moaning and putting
their heads in their hands in despair]

~~~
conanbatt
> For example, paying down debt would be a good idea.

Opposite from a financial standpoint: if interests rates lower in the future
you will be able to refinance.

From a job-vulnerability perspective it always lowers your risk though: better
not to be very leveraged if your income can fluctuate.

~~~
sf_rob
You'll only be able to refinance if a bank is willing. If a recession is the
driver of a fed rate reduction, that seems less plausible.

------
ethn
This could also be a bet that the economy is still yet to improve, as in times
of good economy the coupon rate has historically dramatically increased. To
extrapolate, if the investor expects the economy to peak in 5 years, he would
be incentivized to allocate capital into short-term investments such as
equities and short term bonds as to defer longer-term investing until those
bond yields reach their peak.

~~~
kss238
If investors were putting more capital into short term bonds, wouldn't the
yield of short term bonds drop, not rise?

~~~
ethn
Yes, so in this case investors are instead placing more of their capital in
liquid assets, like public equities. With investors optimistic about the
economy, keeping in mind that coupon rates rise during good economies, we
would expect higher yield rates in the short term with optimistic investors
having both the expectation that equities will outperform those bonds (so
capital is allocated away from bonds) and secondly that interest rates will
rise as the economy improves. This is exactly what we see when we look at the
1-mo to 1-yr bonds.

Coincidentally, the Fed just announced that interest rates aren't expected to
rise this year, so we should see a decrease in the yields of the 1-mo to 1-yr
bonds.

------
throw0101a
It should also be noted that there is a delay between and inversion and a
recession, with an average of about a year:

* [https://seekingalpha.com/article/4250934-yield-curve-inversi...](https://seekingalpha.com/article/4250934-yield-curve-inversion-panic-make-plan-bear-market)

This means it will probably occur in the middle of next year's US presidential
election. :)

~~~
swarnie_
> next year's US presidential election. :)

Any chance the US can extend its terms? An election seems to last an entire
year and be one of the most toxic events possible online.

~~~
throw0101a
> Any chance the US can extend its terms?

Sure. Just amend the US Constitution. No biggie. :)

------
lallysingh
How often does it invert? Had it ever happened without a financial crisis to
go with it?

~~~
majewsky
Here's the last nearly 40 years worth of that curve, with recessions marked
for convenience:
[https://fred.stlouisfed.org/series/T10Y3M](https://fred.stlouisfed.org/series/T10Y3M)
(use the range selector below the graph to see everything)

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dawhizkid
More practically, at least for those _thinking_ of buying a home on a standard
30-yr fixed mortgage, since it seems like the consensus among investors is
that interest rates for long-term debt will fall it makes little sense to buy
anytime soon if you can wait...

Or does it make sense to go with an adjustable rate mortgage instead?

~~~
sokoloff
Buy if you need/want to buy. Refinancing a mortgage after a rate decline is
fairly easy and you’re likely to get a better purchase price in a (locally)
high rate environment and carry that lower purchase price into your refinance.
The diff in purchase price likely more than covers your refinance costs.

------
dafty4
I was worried for this over the past few days (thanks, YC! ;) ), and reading
the thread below see others are as well, but the main solid data I could find
against the yield curve predictor (which the original article doesn't mention)
is that it doesn't hold up in other countries:

[https://www.marketwatch.com/story/an-inverted-yield-curve-
is...](https://www.marketwatch.com/story/an-inverted-yield-curve-is-a-
recession-indicator-but-only-in-the-us-2018-05-07)

So, if you're a start-up in the U.S. and are worried about the yield curve,
just move to Germany, where even though the yield curve is also now inverted
there, the historic evidence shows no to weak prediction of a German recession
due to an inverted German yield curve!

#possibleSpuriousCorrelationFromDataMining

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drinane
Has the yield curve ever gotten really inverted without a subsequent "bend
over" recession following? ... IOW... is there a counter example where we can
say well "maybe this time is a lot like this time?" ... otherwise sounds like
the typical banker control clock in action. Good job monopoly man again! (I
posses no knowledge of a better economic system)

~~~
MR4D
Yes. 1965.

And then it bounced back and forth for the next 4-5 years before we finally
had a recession in 1970.

[https://fred.stlouisfed.org/graph/?g=nn5r](https://fred.stlouisfed.org/graph/?g=nn5r)

~~~
throw0101a
>
> [https://fred.stlouisfed.org/graph/?g=nn5r](https://fred.stlouisfed.org/graph/?g=nn5r)

Note: this graph is for 10Y1Y, while the indicator generally talked about is
10Y3M.

~~~
MR4D
Good point. I know that 10-2's are popular as well.

I used this one because it had the longest history.

