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The U.S. Yield Curve Has Inverted (bloomberg.com)
388 points by acdanger 11 days ago | hide | past | web | favorite | 265 comments





A quick explanation in layman's terms:

I have money on hand and I want to put it into something safe. The US government is constitutionally bound to pay its debts, and is generally considered to be very safe (if not the safest investment around).

The US government sells bonds with different terms. I can buy 1 year bonds, 3 year bonds, 5 year bonds, 10 year bonds, etc. The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note.

Right now, (annualized) rates [1] are approximately as follows:

1 month - 2.30% 6 month - 2.56% 1 year - 2.72% 3 year - 2.84% 5 year - 2.83% 7 year - 2.90% 10 year - 2.98%

Notice that the 3 year rates are higher than the 5 year rates. Generally speaking, if I'm going to lock up my money for more time, I expect a higher return. However, today, the 3 year notes are getting a higher rate of return than the 5 year notes. Why?

Interest rates generally tend to follow the economy at large. When the economy is doing well, people will invest in stocks and other investments and are less willing to pay for the safety of treasuries, so effective rates go up when people bid less at treasury auctions (additionally, the government will take steps via the Federal Reserve to make rates higher). By the same token, when the economy isn't doing well, people want the safety of treasuries, even if they pay less, so effective rates on treasuries tend to go down.

In rare cases, the yield curve will invert. What this means is that investors think that rates of return on government bonds are going to go down in the future. In order to lock in a better rate now, they're willing to pay more for longer term bonds (in this case, 5 year bonds vs. 3 year bonds) in order to "lock-in" the good rates. The assumption is that they won't be able to get the same good rates if they don't act now.

Note that only the 3 and 5 years have inverted. If people were really panicked, you would probably see a more significant inversion, where for example, the 1 year was higher than the 2 year and the 2 higher than the 3, etc.

[1] these rates are actual rates of return calculated based on the auction price paid


As far as insight for how this looks for the US economy, one of the few people I respect when it comes to predictions is Ray Dalio, he says the US debt will start becoming an issue soon. Within 10 years the majority of the US federal budget will go to paying INTEREST on our debt, requiring us to borrow more to pay for the rest which will result in exponentially rising debt and inflation as the government prints money.

Dalio also talks about Thucydides Trap and Paul Kennedy's book on the decline of great powers. He doesn't say it but he seems fairly confident in China surpassing the US as the dominant global power in the near future. The only issue I have is that he seems to think China's high debt is fine compared to the US based on vague reasoning.

The US and the West in general need to wake the fuck up or we're going to be under China's thumb. We've become complacent and assume our status on top of the global hierarchy is guaranteed. China is playing to win and doesn't care about breaking the rules to win


> Within 10 years the majority of the US federal budget will go to paying INTEREST on our debt

All the Federal Reserve has to do is buy US treasures on the open market at higher and higher prices. A premium on a bond pushes the yield lower. Yields at 0% means that the US will not be paying interest on its [new] debt. Yields at negative means that investors will be paying the US.

People and entities buying US treasury bonds is why they yield 2-ish percent right now at all, instead of say 5%.

Regarding 0% rates, the Bank of Japan has already done this with Japanese government treasuries, for a very long time

Regarding negative rates, the European Central Bank has already done this with its constituent country's government bonds, for several years. Primarily German bonds.

The US can do this with more efficacy than those economies, whenever it chooses to do so. Right now, the US Central Bank chooses to raise rates and the US Treasury continues to issue more debt at the higher rates for reasons unrelated to its budget, to be honest just because the market can bear it. The Federal Reserve chooses to have less dubious assets on its balance sheet.

Everything is done in a form of moderation, but the US has a lot of tools to deal with its debt.


You're confusing the yield at market rates with the interest paid by the borrower. If the US were to buy treasuries at above the nominal rate, the market yield would be lowered, because the market yield is the sum to be repaid on the due date minus the purchase price, converted to percent. Neither the due date or the sum to be repaid would be affected.

I'm impressed by how high these rates are. The US 10-year bonds pay 2.9%, according to the top post in this thread. Remarkable. According to Bloomberg, the US pays interest rates like Italy, nearly ten times as high as those of Germany.

https://www.bloomberg.com/quote/GBTPGR10:IND https://www.bloomberg.com/quote/GDBR10:IND https://www.bloomberg.com/quote/USGG10YR:IND


I don't understand why this is surprising. To my understanding it is the case that countries that are bad with money give you a better interest because they're a higher risk to give money to. Germany is good with money, the US is not. Therefore the US gives higher interest than Germany.

Is there a profound insight I am missing that makes this state more unusual than it seems to me right now?


No, just a discrepancy between numbers and attitude. The US of A is indebted almost like Italy and pays a risk premium almost like Italy, and the Americans seem to act as if it isn't a problem.

Truth. If the United States applied for EU membership they would be denied. Too much debt, too much budget deficit.

That wouldn't be the biggest issue. The US is too large and therefore too destabilising for the EU (this is also part of the reason for Turkey). Also, the death penalty.

It might also be an issue that the US is not democratic enough, although there are some EU members (as well as the EU itself) that aren't as democratic as they should be.


And it's in the wrong continent (this is also part of the reason for Turkey).

How your theory explain Japan? Are they extraordinarily good with money?

The interest rate is chosen by the central bank, not by "the market" [1]. A different issue is who try to influence that decision [2].

[1] - http://bilbo.economicoutlook.net/blog/?p=40250

[2] - http://bilbo.economicoutlook.net/blog/?p=32029


There are multiple interest rates.

The FFR (Federal Funds Rate) is the target interest rate for interbank reserve money. (The effective FFR is the average of the actual rates of those transactions between banks.)

And there's the interest rate for Treasury bonds (T-bills) determined via bond auctions.

Now, usually the Fed uses those bonds as collateral to conduct its open market operations that influence the effective FFR to keep it close to the target FFR, but the Fed does not bid on Treasury bond auctions.

Of course if the central bank intervenes and floods the market with cash (and takes assets as collateral, such as bonds) then banks are likely to turn to the Treasury and buy bonds with cash. And the real constraint is of course inflation. The ECB basically does this to keep interest rates low for Eurozone member countries.

Anyway, the central bank can do whatever it wants, but if there were too much inflation no one would want to operate a bank there, so eventually there would be no primary market for gov bonds. (That said the usual Bloomberg/FT/Reuters cries are laughable about how bad poor banks have it with near zero rates.)


the truth is that their theory is totally wrong, and has a whole crowd of people in this thread trying to extrapolate on top of it.

these particular bond yields are not a reflection of "how good a country is with money", this is only a discussion in developing nations and their yields are already 8-20%

so this whole discussion is moot.


That wasn't my phrasing... but isn't Japan's debt mostly bought by Japanese? https://www.statista.com/statistics/756192/japanese-governme... lists foreigners as holding 5%. From the Japanese point of view, Japanese bonds are extraordinary in that they carry no currency risk.

(Does the central bank usually set the interest rate? Why do lenders accept that decision?)


When you say that Japan's debt is mostly bought by Japanese it sounds like it's a particularity of the Japanese people. That's not the case.

Who is buying that debt is really the Central Bank of Japan, so, it's really a political decision.

Yes, the central bank have a target interest rate and operate to keep it inside their chosen parameters.

Lenders accept that decision because they have not other option.

From http://bilbo.economicoutlook.net/blog/?p=40937 :

"That is what the Japanese experience since the early 1990s tells us. And all the stories about special cases; cultural peculiarities, closed markets, etc that the mainstream economists wheel out when another one of their predictions about how Japan is about to sink into the sea as a result of its public debt levels, or that interest rates are about to go through the roof because of the on-going and substantial fiscal deficits; or that inflation is about to accelerate because of the massive monetary injections; and more, are just smokescreens to divert our attention from the poverty of their analytical framework. The Japanese 10-year bond trade is called the ‘widow maker’ because hedge funds who try to short it lose big [..]"


How do you explain that the yield of the US 10y bond was 3% 5 years ago, 1.5% 2 years and a half ago, and it's 3% currently?

Did the United States "get better with money" somehow in the last years before becoming "bad with money" again?

Edit: to be clear, I do know that there are many factors (including as well inflation expectations, for example). It´s not just a question of default risk due to being bad with money.


There are many factors of the global economy that determine the market-determined yield at a given time. The only way a country being "good with money" is in comparison to the yield of other central banks at the same time.

I don't have the data, but if Germany's yield followed a similar trend down then up, but remained below the US throughout, then the hypothesis holds.


For reference, German yield was around 1.5%, 0% and 0.25% on those dates (vs 3%, 1.5% and 3% for the US).

The elephant in the room in this kind of reasoning is Japan.

Japan shows that the narrative of "good country" vs. "bad country" and interest rates beyond the control of the Central Bank have little to do with reality.


Those interest rates don't move on their own. If the competition changes, those interest rates change too.

For example, if the share outlook for the next years looks unusually good/bad volatile/stable (compared to how it looked a couple of years earlier), then that makes shares more/less attractive to investors, and bond issuers have to adjust the rates they offer.


> Did the United States "get better with money" somehow in the last years before becoming "bad with money" again?

Yes, the economy started to boom but then the government went and issued massive corporate tax cuts while simultaneously increasing spending by quite a bit, which means increase in deficit.


> Is there a profound insight I am missing that makes this state more unusual than it seems to me right now?

EXTREMELY

The European Central Bank (ECB) has been buying sovereign and corporate debt, the entire yield curve, with new money with the purpose of making yields negative. This lowers interest rates in the eurozone.

This is its own comedy troupe that has nothing to do with the risk of the countries, especially the anything outside of the Eurozone and ESPECIALLY US monetary policy and the market's expectations of US debt.


> You're confusing the yield at market rates with the interest paid by the borrower

This is true when you're talking about trading a bond in the secondary market. But for primary sales (i.e. Treasury auctions for brand-new bonds that didn't exist before), the debtor (Treasury's) effective IR is a function of the sale price.


I've never seen the perspective where you don't think European Sovereign debt yields are just too low because of European Central Bank debt purchases.

The ECB has been massively inflating the Euro by buying sovereign debt, with the express policy of pushing yields into negative territory so that people invest in riskier assets. OF COURSE that drops the yields of Italian government debt far below what the actual risk is.

This isn't an expression from the collective conscious about the US' finances. wow. or at least it HADN'T been, until now. How long have you been following the debt markets? Your perspective lacks history of anything beyond 3 years...


> All the Federal Reserve has to do is buy US treasures on the open market at higher and higher prices.

Doesn't that lead to inflation?


This is a common misconception: that treasuries somehow don't lead to inflation but reserves (aka electronic cash) somehow do. Why? Both are extremely liquid, but treasuries pay more interest than reserves (yes, reserves do pay interest [1]).

The only difference between treasuries and reserves is, in fact, the interest rate an the fact that we call one "debt" and the other "money". But they are both US federal gov't liabilities denominated in USD. [2]

The bulk of the impact on inflation already happened... when the treasuries were issued in the first place. They aren't waiting to be exchanged for reserves to suddenly cause inflation. [3]

So, if anything, the Federal Reserve swapping one gov't liability for another paying lower interest could lead to less inflation, not more. [4]

[1] https://fred.stlouisfed.org/series/IOER [2] http://bilbo.economicoutlook.net/blog/?p=31715 [3] http://www.cfeps.org/pubs/wp-pdf/WP37-MoslerForstater.pdf [4] https://www.stlouisfed.org/publications/regional-economist/j...


Potentially.

One way to think of the U.S. national debt is as a measure of the future money supply. There are two ways to retire the debt: pay it off through increased productivity (i.e. GDP growth) or print dollars. Debt doesn't cause inflation directly, but it's a potential time bomb if the debt comes due and you can't pay it through productivity growth (or higher taxes).


Does it have to be future US productivity? Or because dollars are the global reserve currency, can it be future productivity of a nation that buys US treasuries?

Pretty much, because that's the only productivity that the U.S. government can effectively tax.

The one big gotcha in international finance is the petrodollar. Going back to the 70s we made an incredibly prescient deal with Saudi Arabia. They agree to sell their oil only in USD and then to invest annual surpluses back into US securities. In exchange we agree to ensure protection of their kingdom and guarantee weapon sells. This arrangement continues to this day in grand fashion. For instance even though Saudi Arabia only has some 30 million people, it's the third largest defense spender in the world spending some $70 billion a year on weapons, with most of that going straight [back] to us. Our influence in turn led to the expansion of the petrodollar beyond just Saudi Arabia to nearly all oil sales.

This doesn't seem like a particularly big deal, until you realize what it does. Imagine the US pumps a bunch of funny money (I'm using a sardonic term just to clearly distinguish between organic/'real' growth) into our economy. This would naturally cause inflation. But here's where the fun kicks in. Oil is still by far the most in demand resource in the world. And now when countries go to buy oil they need to accumulate USD. But now due to inflation a country that wants to buy the same amount of oil needs to keep an even larger reserve of USD on hand. And that's exactly what happens. The USD becomes worth less and countries are obligated to hoover up more USD to ensure access to oil. As that USD starts getting removed from circulation, the effects of the inflation start to abate. Like magic, we can 'print' (not how many is made, but that's another topic) a practically unlimited amount of funny money with minimal economic consequences.

This also explains much of otherwise inexplicable actions in the Mideast and related places. We don't want their oil, we want them to sell their oil in USD only. This [1] is an article from Time in 2000: "Europe's dream of promoting the euro as a competitor to the U.S. dollar may get a boost from SADDAM HUSSEIN. Iraq says that from now on, it wants payments for its oil in euros, despite the fact that the battered European currency unit, which used to be worth quite a bit more than $1, has dropped to about 82[cents]. Iraq says it will no longer accept dollars for oil because it does not want to deal "in the currency of the enemy."" By 2003 we had destroyed the Iraq government and killed Saddam in a kangaroo court. Similarly with Libya, Gaddafi was aiming to create a gold backed 'Afro-currency' which is what he wanted to start selling his oil in. Two other nations which have moved against the petrodollar are Iran and Venezuela.

On the other side of things, this also explains Saudi Arabia. One of the most backwards and repressive nations in existence today, we're still BFF since they act like a loyal lapdog when it comes to the petrodollar. In exchange we let them do just about anything. The CIA has recently stated that Khashoggi's murder was likely ordered all the way from the top. I can tell you how this story will end. Do you remember in 2015 when Saudi Prince Majed Abdulaziz Al Saud had a rape and assault filled 'party' at a rented mansion in Beverley Hills? The 'party' was only stopped once a neighbor called the police after seeing a bleeding woman screaming for help as she tried to scale the fence of his mansion to get away. He was arrested and that's where most media reporting ended. The epilogue is that he was rapidly granted bail, got on a plane and simply flew back to Saudi Arabia with no consequences whatsoever.

---------

This is already getting long enough, but something very important now a days is that the petrodollar is dying. It's a mixture of a perfect storm of a large number different of factors, but it's definitely a dead system walking. And this has major implications for the future of the US economy. To date we've had 'economy armor' on. In the not so distant future, that armor is coming off and our economy will stand or fall under its own weight. And this is when being massively in debt suddenly does start to matter because if you just try to print your way out of it, you would not be able to rely on the petrodollar to protect the economy anymore.

[1] - https://content.time.com/time/magazine/article/0,9171,998512...

[2] - https://www.cbsnews.com/news/saudi-prince-majed-abdulaziz-al...


Thanks for the interesting insight.

While I agree the petrodollar is a big deal, and it does afford us a lot of extra leeway in monetary policy, we can't forget that the US is still an economic powerhouse in many, many different industries. And the power of singularly focused economies like Saudi Arabia is waning.

The shallow reporting is that manufacturing is gone, but the reality is, we have higher manufacturing output than ever. (The fewer jobs needed for higher output is a different story.) We have an enormous lead in software. Intel and Qualcomm are the two biggest semiconductor companies. We have the largest oil and natural gas reserves, much of which is still untapped. A large share of world media entertainment is here. The US pharmaceutical industry accounts for almost half of the world output. World banking and finance is huge. Real estate market is enormous and highly desirable to outside investment. And this is for a country with less than 5% of the world's population.

And that's just some of the big stuff that the US leads the way in. There are so many other industries that the US is still a global player in. What I'm getting at is the the breadth and depth of the U.S. economy is so large that it is hard to comprehend and I don't think the failure of any one industry will be enough to produce significant hardship for the US. Nor does the economy need to rely on the petrodollar for protection in the long term.


What the fall of the petrodollar will change though, is that the US will lose some of its "friends" it could rely on by default. The US will have to work on its diplomacy again. I hope it will not be too much of the gunboat kind.

As we have seen however intellectual property theft and knowledge transfers can even the game very quickly. IP scales infinitely while the meat space is governed by physics.

Great writeup - exactly what I've been thinking about for the past year. What's the impact of US Dollar losing its reserve currency status?

There's a great podcast which sparked my interest in following macro developments, touching the future of the US dollar in particular - Macro Voices - The US Dollar End Game [1] (there are 5 parts, link points to the first one). I'd also recommend listening/reading the transcripts for all the pieces with Jeffrey Snider, e.g. [2] and his blog [3].

[1]: https://www.macrovoices.com/336-anatomy-of-the-u-s-dollar-en...

[2]: https://www.macrovoices.com/239-jeffrey-snider-understanding...

[3]: https://www.alhambrapartners.com/commentaryanalysis/


This gets claimed a lot, but I've never seen reliable evidence for the "agreement", and the oil buying countries wouldn't accumulate USD - the whole point is to spend it on buying oil.

US inflation management is done by the Fed, which has got rather good at it. It's one of the few big success stories of 20th century economics is working out how to do inflation control with interest rates reliably.


Wow. I've been wondering about this since March 2003. Is it really this simple? And how come this isn't common knowledge?

This explains how the US can print money without inflation, why Saudi Arabia is given a pass on a generation of horrible policies, and of course why the Iraq war was performed.


Every time I have tried to raise this point in various forums, I've gotten ridiculed or downvoted, depending on the nature of the venue. Thanks for making the point so clearly, including what challenges the future holds.

From this report https://www.usatoday.com/story/money/markets/2016/05/17/saud... it sounds like Saudi Arabia holds under $120 billion of US Treasuries with the total outstanding US debt being $21.702 trillion https://www.treasurydirect.gov/govt/reports/pd/mspd/2018/opd...

At 0.55% (the figure has possibly have gone down due to the drop in oil prices between 2016 and 2018) they're a significant holder, but hardly a market maker.


This is terrifying, and explains sooooo much! Wow.

They would be introducing money into the economy. The people that had their bonds purchased by the Fed would be holding money that didnt previously exist.

This dilutes the value of an individual dollar. Just like dilution of any asset.

In the context of currencies this is called inflation.

Typically the whole point is for private persons to invest into the real economy, even though it is riskier, because these other new ventures are going to try to put it to productive use, instead of any party just parking the money in a bank account since now it is clear it will lose value just parked.


I can't quite wrap my head around if inflation is terribly bad in this situation. Certainly the Japanese government has been trying to introduce inflation, but the yen has stubbornly stayed pretty high. However, personal debt here in Japan is in a completely different situation than in the US. I wonder if the US is kind of caught between a rock and a hard place. I'd love to hear from someone who understands this stuff...

That Japan doesn’t suffer from inflation is purely an illusion. Rent has been going up, fuel prices have gone up, the volume of stuff you can purchase inside a container had actually declined. Drinks in tetrapaks, foods in packages, etc have all decreased in volume. We’re paying the same amount but getting less as the years have gone by.

It’s cutely termed shrinkflation.

https://togetter.com/li/1190012


>>Yields at 0% means that the US will not be paying interest on its [new] debt. Yields at negative means that investors will be paying the US.

How does this work?

Why should/will anybody give money to anybody for free?


If you had a billion dollars you wanted to keep safe, what would you do with it? If you think the markets are going to do poorly, you might not want to invest it there.

You could just put it into a bank account, but what if that bank goes under? You are only insured by the FDIC up to $250k. You could put it into 4,000 different banks (essentially every bank in America) each with an account of $250k. But imagine the overhead of opening and keeping track of those. How many accountants will you need to have on staff full time? And lots of banks charge a monthly fee if you aren't making transactions every month.

So are you going to take it in cash? If so, where will you put it? You'll need storage, security, insurance... what if the insurance company goes bust and can't pay out?

All those options are very expensive. But you have the option to put that money into a US government bond, the safest place in the world, and it won't cost you a dime. Free storage.

In Europe, there were actually cases of negative interest rates. So people were paying a little bit of money to loan to the government because it was still the safest and cheapest way to protect their enormous sums.


> And lots of banks charge a monthly fee if you aren't making transactions every month.

This is never going to apply to people with $250,000 deposited with the bank. Lots of banks charge a monthly fee if you aren't making transactions and also don't have any money.

Make a large interest-free loan to the bank, and they won't charge you fees for the privilege of making it.


> But imagine the overhead of opening and keeping track of those. How many accountants will you need to have on staff full time? And lots of banks charge a monthly fee if you aren't making transactions every month.

Many retail brokerages will sell you CDs commission-free and keep track of everything for you. They get a commission from the bank for selling them to you. Schwab has a CD search tool with results that keep going page after page after page. I'm sure if you had a billion dollars they'd be happy to have a broker make the purchases for you.


CD is as risky as the issuing bank. If the bank bankrupted, the CD money is gone, down to the FDIC insured amount.

What? Obviously I'm not saying that you'd buy more than $250k of CDs at a single bank. Where are you coming up with this?

Then you are back to the original problem of the overhead of managing 4,000 different CDs. I think you'll negate any gains and maybe likely lose money.

For example, Switzerland currently has the highest negative interest rate in the world. [1][2]

[1] https://www.reuters.com/article/us-snb-results-banks/swiss-b... [2] https://www.ft.com/content/bcc092fc-7743-11e6-a0c6-39e263316...


> You could put it into 4,000 different banks

Or set up 4,000 different legal entities and deposit it all at one bank.


Then that's 4,000 state filing fees, possibly 8,000 tax returns. 4000 1099-int forms... Talk about an expensive nightmare.

Negative interest rates have been a fantastic economic phenomena of the last decade. https://www.ft.com/content/312f0a8c-0094-11e6-ac98-3c15a1aa2...

Lots of tools, but everything has a potentially undesirable or at least unpredictable side effect.

Over the last while, central bankers have been trying to increase inflation rates by keeping rates low, but the market has not been responding as they expected.

..at least inflation didn't go where they wanted it to. Asset prices went up (inflated). It's half based on magic, macroeconomics.


That's because monetary tools are the wrong tool to generate growth and inflation. The correct tool is fiscal policy, but that's politically impossible at the moment in the USA and the Euro-area.

This has become a popular opinion recently because the old proper tools stopped working.

The problem is that the institution responsible for inflation doesn't control the state budget, just central bank lending and banking rules. ...and I don't think you can say with any kind of certainty that "new macro," corbynomics or any of the other current ideas will work, are safe, or don't come with other side effects.

Personally, I'm not sure there's a constantly true answer.

ATM, businesses don't have ways of absorbing more money. You can Google, FB, msft, Amazon or Apple $100m... it probably wouldn't affect what they choose to to in any way. They already have money piling up. Tesla might use the money. They have factories to build, but Tesla's are a rarity.

In that market, to get stimulus/inflation, governments need to spend it themselves.

In 5 years, it could be different.

The problem, imo, with those types of ideas is that public spending is very hard to put in reverse. Even if the value for money sucks, you tend to get trapped spending it.


I would argue it's only "impossible" for the EU. The US could implement sound fiscal policy, but chooses not to. Whereas the eurozone states suffer a tragedy of the commons unless the fiscal structure of the EU changes.

We could go China style and just get rid of the fed and have the government print its own money. That would be way too easy though.

Edit: The difference is when China bails out its banks it doesn't loan the money into existence to do it. The U.S government must borrow the money from the fed and the interest rate is paid back by the taxpayers. Yes, the interest paid back to the fed goes back to the government, minus expenses. However, those with very large amounts of money, trillions in aggregate, can piggyback on this system and earn enormous risk free returns where they would otherwise have to carefully invest in non-risk free instruments. These risk free assets are unavailable to chinese investors forcing these large savings into various productive (or non-productive based on their investing skill) investments in the economy. They can't go into T-Bills either because of strict currency controls. In the U.S the risk-free trillions invested are guaranteed by the power of taxation of the rest of the productive economy. This austerity to pay the bondholders and ensuing liquidation is what trashes the rest of the economy on a regular basis in Western economies. This doesn't happen in China because the banks get bailed out with printed money and they keep on lending without putting the government in debt or requiring taxes to be raised or austerity.

That China has not had a Japanese style prolonged credit bust even though it has been predicted by "The Economist" and other supposedly learned publications on a regular basis for the last 30 years is a sublime mystery that defines explanation because there is a stubborn refusal to objectively understand and analyze the Chinese financial system. I'd say it's a new paradigm in human organization that really defies western understanding because our financial system is so enormously politically protected by all that trillions in passive capital that gets risk free returns.


The Federal Reserve is part of the government.

and the federal reserve doesn't (literally) print the money...

At their discretion they can buy an asset and the person they bought from now has money that didnt previously exist

This is what is being referred to as printing, but yes its just an unlimited asset issuance function in the currency class of a program


Yes, but every bank can create money through lending, you don't need a to be a government agency to do that. The Fed just has less limits because it can just add arbitrary amounts of currency to its balance sheets.

Banks in theory have consequences for lending more than is reasonably available to them. The Fed really can create money out of thin air. That's a big difference.

As long as they satisfy their capital requirements, banks can lend as they please. They tend not to make really bad loans because directors are legally beholden to shareholders to ensure management is appropriately managing risk. The Fed doesn't tend to print trillions of dollars for no particular reason because it is legally beholden to its dual mandate. It's not that different. Yes the Fed can create "reserve currency" and banks can only create "commercial currency" but the distinction is a technical one and doesn't have a whole lot of macroeconomic impact.

The Fed has mandate that has nothing to do with the motivation of the banks. That's a huge difference - they create money for entirely different reasons. And yes, the Fed has an enormous macroeconomic impact obviously.

I don't think you actually responded to anything that I said, so I'm not sure how to reply. Did you just sort all of the words in my comment and pick some at random to respond to?

[flagged]


I know they're considered "independent", that said they're still a central authority created by Congress to control the money supply whose members are presidentially appointed, with a .gov domain name to boot.

Fed Board of Governors are appointed and a part of the government. The actual Fed banks themselves are owned by commercial banks.

But do they report to the government?

[flagged]


For demand control reasons. Money printing can only control supply. The alternative is central bank becoming the basic income supplier, with no abilities to control demand.

[flagged]


The states, which have a central bank, a taxing buro and a government-owned lottery together, do have the necessary instruments to distribute UBI with a suitable demand control mechanism, with just a re-legistlation and re-organisation. US lacks the last one, hence lacks the instrument to do the demand control without debt control nand excessive taxing.

Because we understand that this is a ridiculous conspiracy theory, and also (apropos of nothing) "multinational" isn't a dirty word?

Hint: one of OP's sources is Glenn Beck. Also Rant Paul.


[flagged]


You could easily disprove this yourself. Just check https://en.wikipedia.org/wiki/Federal_Reserve#Legal_status_o...

> However, holding stock in a Federal Reserve bank is not like owning stock in a publicly traded company. These stocks cannot be sold or traded, and member banks do not control the Federal Reserve Bank as a result of owning this stock.

> the "ownership" of the Reserve Banks by the commercial banks is symbolic; they do not exercise the proprietary control associated with the concept of ownership nor share, beyond the statutory dividend, in Reserve Bank "profits."


[flagged]


Buy some Treasury Bonds, and you're also privately profiting from public debt. that's how it works. You need someone to take the other side to have any debt, and there is only one government.

Other than that: you have wilfully ignored the quotes, in what is obviously a bad faith attempt at trolling.


Please don't cross into incivility, regardless of how bad you think other comments are.

https://news.ycombinator.com/newsguidelines.html


[flagged]


Personal attacks will get you banned here. Please post civilly and substantively, or not at all.

https://news.ycombinator.com/newsguidelines.html


> he says the US debt will start becoming an issue soon

Which makes sense, but - I've been hearing this for couple of decades, and it doesn't seem to happen. I am not sure I understand why it doesn't happen and why people seem to care about the mountain of US debt much less than I think they should - but this looks like what is happening for a while. I still think this will become an issue sometime in the future, but I have no idea how one can predict how soon it would be.

> he seems fairly confident in China surpassing the US as the dominant global power in the near future

That depends a lot of what you mean by "dominant" and "near future", I guess. If you pick your criteria well enough, you could both claim China is already dominant (I mean, look at where all the stuff is manufactured! And their population numbers! And their GDP growth!) or that they are hopelessly behind (I mean, look at their GDP per capita - it's on part with Iraq! Nobody thinks Iraq is dominant... Or look at the immigration patterns - are a lot of people from other developed countries dream to go to China, or vice versa? How dominant can be the country where their own population rather live somewhere else?) So you could make either claim without too much effort.


Modern monetary theory is the only one that can adequately explain why it's not a problem in my opinion.

The kind of people who say that the US's debt is totally going to be a problem any year now have generally being saying that for years, as well as saying that about Japan's since the early 90's.

But MMT proposes that a monetarily sovereign currency issuer (like the US, UK, Japan, Australia, New Zealand, etc. but not Euro-using countries, or anybody with a gold standard, fixed exchange rates etc.) actually have the ability to service any debt denominated in their own currencies, and analysis to pretty confidently say that it would not be inflationary to just pay them out (i.e by money creation). The inflation risk was at the time when the spending of the bond money happened, so paying them out with new money is asset neutral - the only difference is it just gives the bond-holder a more liquid asset.

Then there are other useful tools like sectoral balances, etc. that help explain the links between one of the things that really matters (private debt) and how it relates to Government spending and trade surplus/deficit. A few of the twelve or so people who accurately described the great recession a few years before it happened used this method at the core (e.g. Keen, Godley).

It flies pretty hard in the face of conventional economic wisdom, but I haven't yet found an economic theory that holds up so strongly to real world observation, i.e. in explaining why Greece has huge debt problems but not Germany (Eurozone, but trade surplus) or the US (monetarily sovereign), and why Venezuela and Zimbwabe have their problems (debt denominated in foreign currencies, supply shocks, etc.) vs. Japan (monetarily sovereign) while they seem to do similar things, etc.


The thing is that Japan is actually in a deflationary period. You can easily pay debt with increased money supply in that scenario. Similarly, in Japan the debt is owned by the people of Japan and a big question is whether or not that debt ever comes due. There is an ageing population (which means people will want their money back), but there is also no exemption on inheritance tax. Anybody who dies with money in the post office (which lends all its assets to the government) is essentially forgiving the debt for 30% of that money. Japan has also historically had very low taxes (for example very low value added tax) and this is slowly being corrected. It's placing itself in a better position to pay back debt (at the expense of the economy).

Given that, I'm not really sure that Japan is a good example. The US, as well, is in a weird space. China has been quite keen to buy up US debt. This is propping up the US dollar, which I think is an important strategy for Chinese growth. However, I expect the other shoe to drop at some point. Once the Chinese economy is strong enough that they don't want to be the "cheap manufacturing country for the world" (see Japan and South Korea for other examples of this), I suspect they will drop US debt like a hot potato, favouring strong buying power over strong selling power. If the shift their economy and compete head to head with the US in the "value add" sector, I think that debt may cause significant problems.

But this is complicated stuff and I really don't know what I'm talking about :-) It's fun to speculate, though.


> Once the Chinese economy is strong enough that they don't want to be the "cheap manufacturing country for the world", I suspect they will drop US debt like a hot potato

It's also a huge bargaining chip. If China dumped a trillion dollars of US financial instruments at firesale prices over the course of a year, that would cause a lot of mayhem.


> I suspect they will drop US debt like a hot potato

I mean they suddenly decide that the asset they bought in trillions as safest investment available around is suddenly worthless - and not only try to hide it, but actually loudly proclaim that all their holding are worthless (I imagine so that it would be easier to sell them at the best price?) I don't see China doing something like that. First, they would need to find a reason why US debt has become worse investment than yesterday - and second, even if they find this reason, they won't ever "drop it like hot potato" - that would be a suicide (in Chinese conditions, probably a literal one for somebody that would cause such loss of billions to the state).

> If China dumped a trillion dollars of US financial instruments at firesale prices over the course of a year, that would cause a lot of mayhem.

Why would they? Other than collective insanity, there'd be no reason for such behavior.


> I imagine so that it would be easier to sell them at the best price

What? How would telling the world that US debt is worthless help them sell their holdings of US debt at higher prices?


<sarcasm>

> Why would they?

Economic warfare.


But why would they do that? It makes no sense.

It’s like buying a car from a friend then turning around and selling it for a dollar.

You hurt yourself more than you hurt the other person.


Same reason you might fire a $65,000 missile at a $500 truck: Because despite the greater harm to yourself, you believe you can take it and they can't.

China does not have that level of wealth

Not really. China holds a very small portion (less than 10%) of USA debt.

https://goo.gl/images/e6Jmrb


Exactly this. MMT works fine for self-denominated debt.

The classic element of currency crises and hyperinflation is always that you can't print foreign currency: if your trade+investment balance is bad enough, imported items become more and more scarce relative to local ones. This crucially includes oil.


> it would not be inflationary to just pay them out

That depends on what the creditors do with the money. If they keep it in a bank account, the effect on prices is minimal. If they go out and buy a lot of goods and services or financial instruments like stocks, of course that will inflate prices.


The US is at the center of a vast network of multilateral international relations which, even as its individual position diminishes, would continue to exert considerable world influence. Just as did the British long after their empire and with declining GDP.

Of course if the US were to destroy its international network, that would change.

As for "waking up", it appears at the moment the decline is not creating a call for clear thinkers and rational solutions but for charismatic leaders who make Ghost Dance variety promises.


>which will result in exponentially rising debt and inflation as the government prints money.

This analysis is missing something because inflation is a good thing for country debt denominated in it's own currency. Inflating away the outstanding debt is one of the ways to deal with outstanding debt.

If you get a hot economy that results in both high tax receipts and higher levels of inflation (not hyperinflation), outstanding debt can be worn down pretty quickly.


I've been assuming, for many years, that it will eventually go down this way. China, the Saudis, etc will not be happy. But hey.

The u.s. in 2017 spent 6.8% on interest Payments why does he think that will grow 800% in the next 10 years. That seems like a pretty extraordinary claim.

Might be just discretionary spending which doesn't include stuff like social security. Tax cuts ballooned the deficit and Fed increasing interest rates also doesn't help.

https://www.nytimes.com/2018/09/25/business/economy/us-gover...


When you owe a million dollars to someone, you have a problem.

When you owe a trillion dollars to someone, they have a problem.


Only if money is their primary concern.

The US went to war with Iraq and it cost trillions. If China wanted to undermine the US economy and it only costs a few trillion in bad debt it's a bargain if it achieves that goal.


But they don't have a few trillion of our debt. They have about a trillion and that isn't even 7% of the total debt. US citizens and institutions own most of the US debt.

This is absurdly alarmist. While we can all agree debt isn't a good thing, there are a plethora of tools the Fed and the US Govt has at its disposal. It could:

Buy higher than market prices, such as how the BOJ or Eurozone manages its yield curve

Cut social spending programs such as Medicare/Medicaid/Social Security

Cut defense spending

Increase taxes

Inflation cuts existing debt amounts

Or any combination of these. Realistically, most of these.

This yield curve inversion has long been expected and isn't some kind of harbinger of doom. China meanwhile has its own set of precarious economic issues and isn't guaranteed anything.


> ... and doesn't care about breaking the rules to win

Oh. There are rules which countries should be following, even if it's to their advantage not too? ;)


Corruption?! ... Corruption, is WHY WE WIN! – Syriana

The US has a lot of unused taxing authority, historically low inflation and low interest rates. Investors don't see this as a real possibility.

Both the US and China hide a ton of unfunded debt in local municipalities. The question is whose will blow up first, because the survivor will reap the rewards.

> The only issue I have is that he seems to think China's high debt is fine compared to the US based on vague reasoning.

Do you have a source that lets us see his quotes?

I would venture a guess that China's much higher saving rate has something to do with it. Their infrastructure investments are probably wasted at times but it seems much of them do help support further urbanization and economic development.


He self-published a book recently, available as a free PDF or E-book if you're willing to give up your e-mail address:

https://www.principles.com/big-debt-crises/


What does "being under China's thumb" mean in practical terms?

Also worth noting that Republicans/Trump decided to goose the economy with their huge deficit-financed tax cuts at a time when the economy is already strong and heading towards the end of a business cycle. This is the opposite of Keynesian theory which says you should run surplusses during boom times and deficit-financed stimulus during recessions.

OTOH, the bond markets don't seem to care about our current debt load. And the full faith and credit of the US Treasury still backs the world economy.


> This is the opposite of Keynesian theory which says you should run surplusses during boom times and deficit-financed stimulus during recessions.

What this theory has failed to do over time is to prevent the amount of outstanding public and private debt from perpetually expanding.

During boom times, people are inclined to borrow (i.e. create money) to take advantage of the economic opportunities. What the theory says is that we can/should then adopt policies to pay back debt (i.e. destroy money) at the same time, which can then be done without causing deflation. So that's fine, when times are good the amount of debt will expand less than it might have, though it still expands some because slight inflation is so much better than any deflation.

Then when times are bad, we lower interest rates and engage in deficit spending to stimulate the economy. Debts expand a lot.

Notice that neither of these involves the level of debt ever going down, but one of them involves it going up a lot. Advance a few decades and the level of public and private debt is out of control and the interest payments are becoming a large problem.

So how do we get out of this? At some point the level of debt has to go down, but that destroys money, which causes deflation, which is an unmitigated catastrophe that hyper-regressively increases the real value of everyone's huge outstanding debts.

What we need is a way to create money to offset the currency destruction of debt-reduction without just recreating the debt somewhere else. But we know how to do that -- the government can print money. Then raise bank loan interest rates so that people have the incentive to pay down their debts, while at the same time using the money you're printing to lower taxes without cutting services so that people have that money to use to pay down their debts with.

But printing money has a bad name. Failing countries do it a lot, and people think it will cause inflation. Which it does, of course, but that's the point -- inflation to offset the deflation of reducing debts.

So they're apparently being stealthy about it, because there's a back door into this. Instead of having Congress print money, you have them pass a budget with a huge deficit. Then the Fed creates money to buy the debt. Different accounting, same result. Debt held by the Fed "doesn't count" because the treasury pays "itself" when the bond matures.

The issue now is that the Fed needs to get the rates calibrated right. They needed to be raised from zero to get people to actually start paying down debts, but too much and borrowers start to destroy money faster than Congress is creating it through deficit spending. And a little bit of higher interest rates goes a long way when the amount of outstanding private debt is as high as it is.

So now the Fed is trying to hit its inflation target in the face of all this, resulting in some uncertainty about what rates are going to be in a few years.


Nearing the end of a business cycle, possibly. But the economy wasn't particularly strong, it just wasn't terrible. GDP was okay, but employment still wasn't great, inflation was weak, and wages stagnant.

It really feels like the chickens are going to come home to roost on the next downturn due to the massive stimulus preventing the last one from being fully realized while simultaneously putting massive debt onto the US balance sheet.


Right: unemployment is so low, some people have two or three jobs! Wages tell the real story.

I don't think you understand what the term unemployment means. AOC made the same mistake.

yeah, capitalism doesn't work if the government picks winners and losers. A recession is often a good thing, kind of like how natural forest fires clear things out. This time the government intervened and simply kicked the can down the road.

Martin Armstrong's computer Socrates has China surpassing the US by 2032.

Armstrongeconomics.com & ask-socrates.com


He thinks China's high debt is fine because they're the new capitalistic kid on the block, and they have at least half as long as the US did before people start to call the bluff, so to speak.

Everyone wants to grab hold of the horns of the charging Chinese bull.


The government doesn’t print money.

Nice write up. But I want to point out that interest rates are leading indicators of the economy, it doesn't follow the economy.

It's why the inverted yield curve is one of the widely looked at indicators for future economic health.

So the yield curve inversion isn't saying the economy right now isn't doing well. What it is saying is that the market ( or a large percentage of institutional investors ) think the economy won't do well in the future.

As you noted, it's only a slight inversion of only the 3 and 5 year, so it isn't that alarming for the moment.

Just as important as the yield curve is what the FED is going to do with interest rates. If they consistently raise it every quarter for the foreseeable future, then the odds of a recession will increase considerably.


Thanks for this. It really helped.

So if we look at the very long term rates, do those signal that we are broadly confident that the US economy will be healthy long term? Or is there no signal there?


In general, when longer term bonds have higher yields, this is investors saying "compensate me for the opportunity cost of not being in stocks or riskier assets over that term". What matters is that the yield curve goes up as the maturity date goes out in the future, signaling a healthy outlook for risker assets. If the yield curve inverts, this can be interpreted as investors saying "the longer term outlook for riskier assets like stocks is not good, so I don't need compensation for longer term less risky bonds, just get me out of the market." It is a remarkably reliable indicator of future trouble for stocks.

Not really, short-term interest rates are set by the fed and long-term interest rates are determined by bond investors betting what the avg interest rate will be over that time period. So when the yield curve inverts, investors are betting that the fed will have to cut rates in the future (because of a recession or other reasons), making the long-term interest rates lower than the current short-term rates.

I think you might be looking at a different side of the same coin as GP.

Betting that the Fed will have to cut rates because of a recession is a bet against equities and other risk assets.


But the biggest of those bond investors is the fed. That's actually how they 'set' rates, by doing open market operations in which they buy and sell bonds of varying maturity dates in order to adjust the supply of money. They never want the yield curve to go inverted because it means the growth prospects for the economy are no longer there.

For long term rates nobody really knows because for the last 10 years central banks have been buying trillions of the stuff. The US Fed has started selling some and long term rates were rising until the Nov stockmarket selloff. No one is sure what is going to happen next. If we go into recession again with no inflation - long term rates are too high. If inflation picks up, current long term rates are way too low. If the government keeps running huge deficits and Fed keeps selling, long term rates could pick up. Unless Europeans and Asians start buying again of course.

@chadash thx for the explanation.

With regards to > that investors think that rates of return on government bonds are going to go down in the future.

Does it mean that investors think that US government will pay 'less interest' in the future for these 5 year bonds ?

If yes, does that mean that investors think that US government will be willing to pay less to its lendors (the bond holders). Which, would also mean that bond buyers think it is good time now to lock in a higher rate.

(seems like a good thing if one is a US taxpayer, if the gov will pay less to money lenders, unless US people are starving...).

For example, Ukrain's 3 year bond pays 18%

http://www.worldgovernmentbonds.com/bond-historical-data/ukr...


I didn't want to get too much into the weeds, but it's actually the market [1] that determines the rates. What the US wishes to pay is irrelevant.

As stated in my original post, the treasury sets an interest rate and a face value on its bonds.

Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more).

So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields.

[1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now.

[2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example.

[3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).


>The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note.

Its important to point out that these are not market-based auctions. The Federal Reserve regularly steps in to purchase its own bonds (in effect skewing the price of the auction). The FED currently holds ~4 trillion worth of bonds purchased in prior auctions (its not currently increasing its holdings but it is repurchasing).

https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

Central bank purchasing their own bonds can act to prop up the market, but also to disrupt market forces by keeping a "thumb on the scale". While this was initially done as an attempt to stimulate the markets after the crash of 2007/2008, it was never ceased, putting the whole financial system into real jeopardy when there is another crash and central banks have used up all of their bullets. This is a financial experiment with an uncertain end. The balance sheet of the BOJ as recently passed its annual GDP.

https://www.reuters.com/article/us-japan-economy-boj/bank-of...


The FED has been unwinding the balance sheet this whole year. Granted the rate started out at 16 Billion/month and was capped at 40B/month. So there have been plenty of jokes about how it will take years to unwind 4 Trillion. I think we have just passed 150 Billion there is a pretty cool chart out there somewhere.

The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP.


>The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP.

One of many concerns! Given that the solvency of the USA and the entire global economy is predicated on interest rates not rising substantially, things are going to get very interesting (not in a good way) next time we have an economic crisis.


"[..] The balance sheet of the BOJ as recently passed its annual GDP."

Yes, and where are the promised terrible consequences?

The true is the markets have to dance whatever the Central Bank sings [1].

[1] - http://bilbo.economicoutlook.net/blog/?p=40937


And, as unpopular as bitcoin is, the above description of actions taken following 2008 is why bitcoin was invented.

OK, I have a (probably stupid) question. If the 3-month T-bond rate is say 2.32%, does that mean that I can buy such a 3-month security 4 times in a row in a given year to get a total of 4 * 2.32 = 9.28% ROI on the money I am using to invest? Actually, the return would technically be higher than since the second, third and fourth times I am buying the T-bond I will use not only the original cash I had on hand but also the 2.32% return I received each time I bought the T-bond. So, assuming everything is re-invested in the 3-month T-bond the total ROI for a given year would be about 9.6% (assuming the rates stay the same of course). A ROI of 9.6% is quite good and beats stock market return over most years, while also being virtually risk-free. Am I missing something here? Why invest in a (risky) stock market unless you can reasonably expect a return in the double digits that can compensate for the extra risk, compared to a 9.6% risk-free ROI from T-bonds? Please pardon my ignorance and thanks in advance.

Nah, those are annualized figures. Buying a three months four times will give you ~2.32.

OK, thanks. Then what would buying a 3-month one once a year give me? Still 2.32%, or 2.32% / 4? Also, since right now the 3-year bond offers more than a 5-year one, why would anyone prefer to buy the 5-year bond? Doesn't the 3-year one offer the same (or better) return over a shorter period of time?

2.32% / 4. Technically the "/4" may not be exactly "/4" depending on the bond. It is called day count fraction and for some bonds the rules can be quite complex. But the basic idea is to prorate ("accrue") the interest rate to the time you held the bond.

2.32% / 4.

And hopefully that answers your second question as well.

The rate is annualized, meaning the profit if you held the bond for 1 year.

So a 3 year bond at 2.32% pays a 2.32% annual interest rate. Interest payments are made twice a year. A 5 year bond at 2.32% pays the same rate of return — 2.32% interest per year, but in that case guaranteed to continue paying at the same rate for 5 years instead of 3.

The rate is the annual rate. The term is for how long interest payments are made and how long until the bond “matures” — when the face value is paid back.

If people think rates are going to go down in the future, then they will accept a slightly lower rate if it is locked in for a longer term, which is the idea behind the “inversion”.


>Doesn't the 3-year one offer the same (or better) return over a shorter period of time?

Later part of the OP's post was mostly focused on this question :)


In addition to the comments about APY, this analysis also assumes that you'll get the same 2.32% rate when you buy another bond three months from now, six months from now, etc.--correct me if I'm wrong, but that rate isn't guaranteed to hold up through the year.

Yes, that's why I said in my post "assuming rates stay the same". But thanks for chiming in anyways.

All rates are APY, not the time interval of the bond.

Great explanation.

What about the fact that US treasury is issuing more bonds to fund extremely large deficits? How does that play into the equation you described?

Wouldn't so many bonds flood the market with bonds available and thus raise the yield rates on 10-year?


The Treasury Department sells a variety of securities. I wasn't able to find anything about how they choose auction amounts, but it would make sense for them to borrow using whatever kind they can get the best rate on, rather than 10-year bonds in particular. If so, the mix would depend on market demand.

I think it's more common in developing nations. I saw this when doing fixed deposit in India and was very surprised. It makes sense as it is expected that the safety of the investment will increase as the country develops and the interest rate is likely to fall, as it is currently three times as that of US.


Shorter summary - historically, yield curve inversions have been pretty reliable predictors of recession.

There are no certainties, of course, but the probability is pretty high that in the next 6 to 24 months we'll see negative economic growth and increasing unemployment.


How well does the U.S. yield curve perform as a prediction market for S&P 500 prices? Is there a strong correlation between what investors expect will happen in 3-5 years (ie the yield curve), and what actually happens?

To answer your question, I found this work [1] that uses yield curve information and a basic 200-day moving average. The rule it uses is simple: Go to cash if: (1) yield curve of 10-year treasury minus 2-year treasury has inverted and (2) S&P is below 95% of its 200-day moving average and (3) the next recession has not yet occurred. If in cash, buy if S&P is above 103% of its 200-day moving average.

As can be seen, based on historical data from 1950-now the yield curve signal beats S&P 500 marginally (+110 basis points annually). However, I would not implement it as is, because this could be noise. Looking at the two tables above, the yield curve + 200MA strategy exhibits a problem commonly seen using these types of moving average strategies--whipsaws--which means buying in at a price and being forced by the strategy to sell at a lower price. In table 1, Buy in at at 65.24 and sell at 62.93 is an example of a whipsaw. [2] is an excellent resource if you are interested in learning more about these types of strategies.

[1] https://seekingalpha.com/article/4183120-superior-investment...

[2] https://www.philosophicaleconomics.com/2016/01/gtt/


I think it's so hard to tie these together, because there are a lot of motivators that can lead to the yield curve inverting, also there are different yield curves that can invert. Currently talk is that the 5/30 is what we should look at, traditionally it is the 2/10, the one everyone is talking about now is the 3/5... and just one bps for the 3/5... and actually when people talk about the indicator they really mean for a quarter... well, some do. Sometimes people say a month. Or... some other amount of time.

Basically it's a lot of noise. It doesn't mean nothing, but...


Hi odonnellryan,

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--K


Financial time series are usually too noisy to make predictions on those time scales. In reality, there's also not enough data when your forecast window is that far into the future.

Great write up. Also in layman's terms: what do investors generally do when gearing up towards a recession, other than buy long-term (and low-yield) bonds in advance?

Does it also mean that the money in short term will get more expensive?

Capital One is offering money market savings accounts earning 2.0%, with no caps, and no time limits. Sure, I could buy a 1 year bond, and earn the extra .72%, but I rather have the flexibility to withdraw at anytime with the Capital One money market account.

The classic recession signal that most follow is a 2-10 inversion.

> The US government is constitutionally bound to pay its debts

Since when? Please point me to the part of the constitution that says that.


Since 17someting:

    Article VI
> All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution.

It requires a minimum of good faith, which you possibly lack. But it clearly implies that debt exists, and that it can be valid. The fact that valid debt is to be repaid is not clearly spelled out in the constitution, because the founding fathers did not believe there would ever be a time where idiot vandals trashed about requiring every minute detail to be proven from first principle.


That doesn't mean the government can't default on its debts, it means that the new government would assume the debts of its predecessor. Context from Wikipedia:

> The states and the Confederation Congress both incurred large debts during the Revolutionary War, and how to repay those debts became a major issue of debate following the War. Some States paid off their war debts and others did not. Federal assumption of the states' war debts became a major issue in the deliberations of the Constitutional Convention.

As for the rest of your comments, I used to like it when HackerNews was somewhat civil.


Art. VI only says that the US under the Constitution chose to assume the debts of the US under the AoC.

What seems closer to what you want is the first part of Section 4 of the 14th Amendment: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”

(Which still, strictly, doesn't say the debt will be paid, only that it's validity will not be questioned.)


Article 14, part 4:

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.

To be fair, there has been some debate into how this is interpreted as far as the constitutionality of debt ceilings if they would cause the government to default on its debt. The US has always paid its debts, so the question hasn't been litigated and decided in court.

In any case, constitution or not, the biggest reason not to default on debts is that doing so makes it far more expensive to borrow in the future.


There is a 1 bps spread between the 3-year and 5-year US Treasury (2.84 vs 2.83) as of close of market today.

While somewhat noteworthy, it's not huge (yet). When people talk about yield curve inversion and it being an indicator of recessions, it's much more common to compare the 2-year with the 10-year. Currently that sits at 2.83 (2yr) vs 2.98 (10yr). While the shorter spreads do often invert first, there is no requirement for the longer spreads to follow.


Here's a graph plotting the 10 vs 2 year spread:

https://fred.stlouisfed.org/series/T10Y2Y


Going off of that graph, we could 'bounce' and remain at non-inverted levels for a few more years as in 1995. But once the rates truly are inverted to a substantial degree, a recession generally follows within a couple years.

1995 was special, though, since that was the start of the Dotcom boom. Every year after 1995 and before 2000, the Dotcom bubble got bigger and bigger. To bounce like 1995, we'd need an economy like 1995.

For 10-year vs 3-month Treasury bond rate average time from inversion to recession start since 1969 is 12 months (SD 3.83)

source: https://en.wikipedia.org/wiki/Yield_curve


> While the shorter spreads do often invert first, there is no requirement for the longer spreads to follow.

I mean, there's no "requirement", but historically their movements correlate with each other closely with a small amount of offset.


Sure, but I guess what I'm trying to say is that the probability of the longer spreads inverting based on this is nowhere near 100%. A tiny amount of good news in the market tomorrow will probably reverse this short term spread inversion. Bad news will likely make it worse, but it's not really at a level yet where it's indicating much yet imo.

Cleveland fed uses that spread to predict GDP Growth (2%) and probability of recession (20%)

https://www.clevelandfed.org/our-research/indicators-and-dat...


Banks borrow short and lend long.

Meaning they take short-term deposits (e.g. current account balances) and make long-term loans (e.g. mortgages). They normally make a profit, because they borrow short paying low rates, and lend long receiving high rates. Easy. Head to the golf course.

If the yield curve inverts, banks lose money ... their capital ratios and share prices fall ... they become more risky and less creditworthy ... people withdraw their money ... bank runs, ATMs stop working, bail-ins ... your current account is permanently unavailable (see Cyprus, Greece).

Note that many banks, especially European banks, are starting from an existing almost-bankrupt state, with plummeting share prices (DB, UniCredit, BBVA, BNP). If the EUR yield curve inverts, they all crash faster than an anvil without a parachute (DB is already giving the anvil a good race).


Can someone explain this in dumb person language? All I get is that the yield that bonds give is below zero, meaning you lose money holding them? And bonds are buying debt on faith the issuer will pay, and as the issuer pays, you get dividends.

And I think the interest rate is inversely proportional to the amount the bonds pay or something like that?

Just explain in simple language. :)


Not quite that. The yield for a 5-year note is less than the yield for a 3-year note.

More generally, a yield curve inversion is when the interest rate you earn on short-term debt ends up higher than that of long-term debt of the same quality.

I don't think the issue is that the inversion causes the recession. It's more an indicator of pessimism in the market. It implies that investors think that interest rates are going to get worse, so they look to buy more longer-term bonds in order to try and lock in current yields for a longer period of time. That increases demand for those assets, which drives down their price^H^H^H^H^H yields.


> That increases demand for those assets, which drives down their price.

I'm not an economist but this seems wrong


Actually it does not drive down the price but the yield. When the price goes up the fixed payment is a lower fraction of the price of the bond. Hence the return goes down.

https://www.investopedia.com/terms/b/bond-yield.asp


He made it most of the way there. Increasing demand drives UP prices, which drives DOWN yield.

This was corrected above, but for those who are interested: For bonds, yield and price are inversely related.

Buying a bond means you are lending money now, in return for more money later. The amount you get later is made up of the price you pay now plus the interest, ie the yield. So if the yield goes up, the price goes down. (You don't have to pay as much for a bond when the yield goes up).


That commenter should've said the yield is driven down. The US government wants to borrow at the cheapest rate of interest. If more people want to lend to them, they have more options and can pick the cheapest option.

> The US government wants to borrow at the cheapest rate of interest

This is categorically not true. If it were then Congress would pass legislation ordering the Fed to buy securities from the Treasury at whatever rate it liked (or abolish the Fed altogether and just directly spend money into existence). Congress in fact wants to provide savings vehicles, it's not actually necessary for Congress to borrow to fund the federal government. Sure it's necessary under current law but Congress by definition can change that law. That it chooses not to is an expression of a preference.


Drives down their yield would be more correct, which is to say the asset becomes less profitable.

Haha, gotcha. edited.

yes, OP meant drives up the price and drives down yields

But it's not just the bond market in isolation that is relevant, it's the possibility that money moving into longer term notes could mean that people are making bets that nothing in the overall market will yield more than the long term debt instruments.

Ah, so this is basically the market saying the US government's ability / willingness to pay debts today is greater than it will be in the future?

Or is it simply about interest rates, I guess, since higher interest rates cool the market and lower interest rates warm the market. So investors are thinking a recession is coming and the Fed will need to lower interest rates to stimulate.


I don't think it's that - US Treasury Securities are always regarded as being nearly as safe as cash.

But, in a recession, the stock market tends to nose dive, which prompts a lot of people to flee to fixed-income securities because they're viewed as being safer. Which would also drive down yields.


Great, thanks for your help. I'm understanding much better now about how bonds are priced and how it relates to their yield. :)

> US Treasury Securities are always regarded as being nearly as safe as cash

Not always:

https://en.m.wikipedia.org/wiki/United_States_federal_govern...


From the page you linked:

"Market consequences ... U.S. treasury bonds, which had been the subject of the downgrade, actually rose in price and the dollar gained in value against the Euro and the British pound, indicating a general flight to safe assets amid concerns about a European debt crisis.[31]"

Basically, no one believes rating agencies with respect to the US paying its debts - but they do believe that if the US government is in chaos, it will be bad for the world economy.

One should also remember that US bonds are denominated in US dollars, which the US government can print. Also, if you're comparing to "cash" you probably mean "US dollars" which are backed by the "full faith and credit" of...the US government.


For many years the US federal government wasn't rated at all, because it was correctly seen as the absurdity that it is[1].

[1]https://tradingeconomics.com/united-states/rating


Not quite that.

Bond prices go down when interest rates go up. As such, an investor who thinks that interest rates will go _up_ will reallocate from long-term bonds to short-term bonds, rather than the opposite as you stated.


Actually they still pay a positive amount (about 2.8%/year). What's significant is that now the 3 year pays slightly more than the 5 year (2.84% vs 2.83%). Usually longer term treasuries pay more because the buyer assumes more risk to have their money locked in to a specific rate for a longer term.

However, when the market expects that maybe interest rates will be falling in the near future (like in a recession), it can prefer to lock in the current rates for a longer term. When markets expect recessions, people tend to buy long term treasuries over short term treasuries which causes the yield of long term treasuries to go down and the yield of short term treasuries to go up.


If my understanding it correct, I'm pretty sure it means the yields of short-term investments are better than long-term investments with the implication that investors feel like the economy is fine now but won't be in the not to distant future. In short, they think there will be a recession so they want to make money now while the gettin's good.

In the article there is actually a link hidden that provides just that info

> Click here for a QuickTake on the yield curve

https://www.bloomberg.com/news/articles/2017-12-11/the-yield...


Oh awesome, thanks!

It's significant because an inverted yield curve is a historical indicator of an impending recession.

https://www.nytimes.com/2018/06/25/business/what-is-yield-cu...


Here's a YouTube video illustrating it quite nicely IMO: https://www.youtube.com/watch?v=tZwChe0WvO4

For whatever reason, if people are optimistic about the market, the yields are higher long term versus short. (You need to get paid more interest to hold a 10 year bond than 2 years because you assume the rates go up)

The general reason people think rates will go down in the future is if a recession is coming, and the govt will lower them. In this case the rates may high for 2 years, but lower long term. (The 10 year rate is just a weighted average of interim rates)


Why would rates go up in an economy that is getting better? Is it only because the Fed would increase rates in response to the improvement? In a free market, I imagine they would go down because people would trust the government's ability to pay back their bills and thus bonds would be more in demand?

It’s not credit risk of the govt. It’s the govt raising rates to slow down inflation. (In a downturn, prices go down, so rates can be lowered without an inflation risk)

Treasuries (i.e. bonds) are issued for different terms, such as 3-year and 5-year terms. Typically longer term treasuries have higher yields because you're loaning your money for a longer period.

The Yield Curve™ is the difference between the yields of two treasuries -- in this article it is the 5-year Treasury note minus the 3-year Treasury note. When this difference is negative that means the 5-year note has a lower yield than the 3-year note.

Investors typically want the highest yield possible, so they'll invest in the 3-year note rather than the 5-year note. A negative spread (difference) can indicate that investors are more confident about the short-term than the long-term.

Note there isn't really a single "Yield Curve". You can take the spread between any two terms of a Treasury note -- e.g. the 30-year and 10-year or the 10-year and 2-year notes. The Federal Reserve provides a spread for the 10-year minus 2-year: https://fred.stlouisfed.org/series/T10Y2Y


A yield curve typically means taking not just two instruments, but as many as you can get, so there really is just one yield curve for any given kind of instrument.

Although there is enough variety in the details of government bonds that you could argue there is more than one there. The proposition that there is a single yield curve is more obviously true for things like interest rate swaps.


It's a potential warning sign of a coming recession:

https://en.wikipedia.org/wiki/Yield_curve#Relationship_to_th...


It means institutions aren't betting on the long term growth of the economy and instead are tryna capture short-term gains.

No - what happened is the yield on the 5 year treasury dropped below the 3 year one.

chadash wrote a nice explanation further up in the thread

Sorry for the copy pasta, but they say it better than I do.

"Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed."

https://www.investopedia.com/terms/i/invertedyieldcurve.asp


So I read the article but I don't quite get it.

A 5-year bond now has a lower yield than a 3-year bond? How is that even possible? Wouldn't anyone who wants a 5-year bond just buy a 3-year bond and then put the cash under their mattress after 3 years?

Is the idea that in 3 years' time, negative interest rates will be widespread, physical cash will be abolished, and figuratively keeping the cash under your mattress isn't even possible?

EDIT: And why don't arbitrageurs buy up 3-year bonds and sell 5-year bonds?


> A 5-year bond now has a lower yield than a 3-year bond? How is that even possible? Wouldn't anyone who wants a 5-year bond just buy a 3-year bond and then put the cash under their mattress after 3 years?

Today's rates show the 3-year yielding 284bps and the 5-year yielding 283bps (the same as the 2-year) [1]. Let's consider three hypothetical buyers' outcomes. To keep things simple, we'll assume interest isn't re-invested.

One buys the 5-year. $10,000 of their principal would turn out $1,415 in interest [2]. Another buys the 3-year, keeping the principal as cash on redemption. $10,000 of their principal turns into $852 in interest [3]. Immediately, you see why the 5-year is a better buy for a 5-year investment horizon than the 3-year.

Consider a third buyer. They buy the 3-year with the aim of re-investing. To get the $563 difference between the 5-year and 3-year total interest pay-outs, they would need to buy a 2-year bond yielding 282bps when the 3-year matures [4]. If rates are lower 3 years' hence, the 5-year investor will have done better. If rates are higher, the 3-year buyer with intent on reinvesting will have done better.

This reinvestment risk, which incorporates the market's views on future interest rates, is what the yield curve essentially reflects.

[1] https://www.treasury.gov/resource-center/data-chart-center/i...

[2] 2.83% x $10,000 x 5 years

[3] 2.84% x $10,000 x 3 years

[4] [($1,415 - $852) / 2] / $10,000


Thats not how it works. If 5-year bond has yield x, for principal P you receive Px for 5 years. With 3-year bond with yield y, you get Py for 3 years. If y > x => after 3 years rates will be lower than y. So you will get lower than P*y for the last 2 years (of 5 years).

Ahh, got it.

So the overall yield is not lower, just the annualised yield.

That doesn't sound like nearly as much cause for alarm.


The alarm is that bond yields are more or less `yield = (k / economic confidence)` - if people are confident then they don't buy bonds, so the price of bonds falls, so the yield (which is annualized return) rises. (Thus recessions lead to falling interest rates as people seek safe harbors for money, making credit cheaper.)

What this means is that the bond market thinks available bond yields for cash-on-hand will be lower in three years than five, so they're willing to take a hit now to lock in the longer-term payout. That reflects serious economic pessimism.


It's not a cause for alarm per se, but the inverted yield curve means that the bond market is feeling pessimistic. Rate inversions often happen before recessions, but they're not a fool-proof indicator.

Which is why i think that describing the yield curve in terms of rates of bonds running from now until some date in the future (which is what we do when we talk about raw treasury rates, or zero-coupon bond rates, another common form) is really unhelpful, because it disguises this structure.

We should instead talk about it in terms of expected instantaneous, or at least short-term, forward rates. For example, what is the expected rate for a three-month T-bill starting 1, 2, 3, 4, or 5 years from now?


Right, but the 3 year bond would only pay 3 years of interest. If interest rates are significantly lower 3 years from now, then reinvesting in a new (lower interest) bond at that point would give you a lower return over 5 years than the marginally lower 5 year bond would give you now.

So, why does this happen? Well, it happens when the markets expect interest rates to drop between now and five years from now.

Why might that expectation exist? Well, it might if bond buyers were anticipating a recession.

At least that is how I understand it. Feel free to correct me.


I see it as investors betting that before 5 years from now we'll see another recession and the Fed will be forced to lower interest rates, hence why 5 year yields are trading below 3 year yields.

"A 5-year bond now has a lower yield than a 3-year bond? How is that even possible? Wouldn't anyone who wants a 5-year bond just buy a 3-year bond and then put the cash under their mattress after 3 years?"

Your confusion is precisely why it's a bad thing. Ideally, longer-term bonds have a higher yield, as that would mean we collectively are investing in high growth over a long period of time. That is, the economy grows.

When the inversion happens, then the short-term bonds have a higher yield, which means something is wrong with the economy in the long term. We don't know what's wrong with it, it's just a signal.


An inverse yield curve predicts lower interest rates in the future as longer-term bonds are being demanded, sending the yields down.

Suppose for instance you believe that the Federal Reserve's fiscal policy calls for it to raise short-term interest rates, and you expect that to cause a rise in long-term rates shortly as well. That belief would reduce your appetite for longer-term bonds, for the time being.

At large enough scale there is no mattress. Keeping a billion in cash has storage and transport overhead, while keeping it in bonds is a simple matter of accounting.

Maybe you will have a billion in physical cash if you are running a narco empire

The 5-year yield is lower to mitigate the uncertain risk (to the issuer) of paying above-market during years 4 and 5.

they buy the 5-year because they don't have trust in the US economy and want to lock into an interest rate before they decrease further

Yet they have enough trust in the US economy to assume that inflation won't ruin their earnings over the [longer] 5-year period.

If anyone is curious how this has compared over time for more context, this is a great visual tool to graph/animate the yield curve:

https://stockcharts.com/freecharts/yieldcurve.php


Worth noting that unlike previous business cycles the Fed is manipulating both the long and short end of the curve. Quantitative Tightening (QT) is the Fed's program to sell and/or let expire the long-term Treasuries it bought during QE 1/2/3.

As the same time, the Fed is raising short term interest rates using its tried-and true headline short-term interest rate target.

This is not just unusual - it's unprecedented. QT has the effect of suppressing the yield curve inversion signal (by artificially increasing long-term rates). As a result, the gap between the next yield curve inversion (the one mentioned in the article hardly qualifies) and the next recession could be surprisingly short.

Backing off now on QT and short term raising, with unemployment at a very low point and inflation ramping up, would be lethal to the Fed's credibility. Whatever Powell says to try to talk the stock market up, he's locked and loaded and can't do much beyond stick with the program: triggering the next recession.


This is a bit alarmist. Please see [1] or [2] for Jerome Powell's thoughts on recent yield curve trends and what it means for the economy.

[1] https://www.bondbuyer.com/articles/powell-doesnt-see-high-re...

[2] https://www.youtube.com/watch?v=p7Z46p06WS4


Meanwhile I'm sitting in all cash thinking "Hurry the f up".

(Yes yes I know don't time the market)


Why can't he slow QT?

> QT has the effect of suppressing the yield curve inversion signal (by artificially increasing long-term rates)

i.e they could, but the long end yields will drop below where they are now, on top of signaling to the market that things are worse than what is admitted if they have to stop.


Fans of Planet Money’s “The Indicator” are no doubt imagining Cardiff prepping new yield curve material.

Yup, I love that he's so enthusiastic about the yield curve that I was immediately reminded of him when I read the title.

I immediately thought of this too. Can't wait for the episode.

Question: Are there any other recession signals which have also recently presented themselves? I know very low unemployment, which we have, is one. Are there others?


I've heard that container shipping, and container shipping fleet expansion are important indicators, but I've also read that it went haywire in 2008, and the tradewar isn't helping.

a better way to understand the causality between yield curves and recessions is to look at it from the perspective of the banking sector ... banks/lenders primarily borrow short-term and lend long-term. They pay depositors short-term rates and earn the long term rates on loans. If this carry trade turns negative, it makes it difficult to make money lending, they get more conservative and collectively they tighten credit conditions on the economy as whole.

One thing I'm interested to see if anyone can discuss what's different this time (i.e, Fed has ~4x more assets on it's balance sheet [and the roll-offs], corporate have ~2x more debt, labor force participation rate is at levels not seen since the 60's, 4 eurodollar "events" since, US gov debt levels since) and how it could theoretically affect the yield gymnastics?

Some banks keep saying 2020 is the big one since that's when most of the corporate debt will be need to rolled over onto higher rates, but I'm of the mind we don't even make it that far because of even shorter term liabilities (think corporate buybacks with debt at higher rates that will increasingly put pressure on balance sheets m/m, liquidity pressure risk assets, devaluation on collateral) in this environment.


Good questions. Two differences to consider vis a vis past late cycle moments: US corporate profits haven't peaked, and the politicians could have a better claim on being part of the problem than on being part of the solution. I was tempted to add "leverage" but that's too slippery for a concise discussion.

Profits: it took about two years peak-to-trough for profits/GDP to correct during the past two recessions. Unless you see sudden stop risk, this suggests the US corprorate sector isn't staring down the barrel of a massive deleveraging...yet.

Politics: public support for legislative non-compromise does not speak to the kinds of policy fixes applied in 2008-9. Executive belligerence toward the Fed doesn't seem helpful either. As much as markets may have appeared to ignore US political risks while momentum was positive, it seems credulous to think this more of a divorce than a separation.

There are other quantitative arguments that the turn in the cycle is not here yet (e.g. employment, notwithstanding participation rate). But the prospect of a return to political gridlock is, to me, the most important risk contrast with recent past cycles.


> All it means is that the central bank will probably leave interest rates steady, or even cut a bit, in 2022 or 2023.

This event reflects the relative preference of the markets for the 5 yrs compared to 3 yrs, producing lower effective yields. This is probably done to secure a certain rate for a longer period of time.


It doesn't have to be this way. The curve was unnaturally flat to start with due to Operation Twist. As the Fed unwinds its balance sheet, it seems only naturally to also unwind the effects of Operation Twist at the same time.

Can someone concisely explain what yield curve inversion could indicate?

I can think of a few explanations for why long term yields are going lower:

1. Long term yields going lower because there are far fewer places for capital to go to besides US treasuries, indicating slower business activity

2. Short term yields going higher because no one wants to buy short-term treasuries because there's something else to invest in or expect higher return for short term investment?

Are these the only two reasons? Why are people so fearful of inverted yield curves?


Investors want to buy long term bonds because they suspect the interest rates will get worse, so they want to lock in the current rate for a longer time. It signals that investors are expecting a recession.

People are fearful of inverted curves because it means the market is pricing in a predicted recession. Of course, that does not mean that a recession WILL happen, just that it's the current market expectation.

During recession scenarios, the Fed cuts interest rates to facilitate borrowing and inject more capital into the economy. So a lower 5yr rate means the market is expecting a more aggressive monetary policy in 2023


Inverted yield curves mean that interest rates are expected to fall. Interest rates falling mean that (a) demand for money is falling and/or (b) supply of money is rising. In economic recessions, the demand for money often falls and the supply of money often grows. Therefore, an inverted yield curve indicates an increased forecast of recession chances over the next few years.

(I am not an expert and could be wrong.)


Good explanation. Thank you.

But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to be through the roof.


[Edited] As described by the IS-LM model, government deficits tend to do three things:

-Increase output (more people working/getting paid)

-Decrease economic investment (investors put dollars in treasuries instead of private sector projects)

-Increase interest rates (fewer investor dollars to go toward private sector projects, since some have been diverted to government debt/production)

However, the Fed usually tries to account for this force in their monetary policy (see monetary offset):https://www.bloomberg.com/opinion/articles/2018-07-20/fed-im...


Doesn't debt issued by US treasury have to be funded by private holders of US dollars? Or does the Fed simply buy out the debt issued by treasury?

I thought the Fed simply buys only a small portion of US treasury debt (thus printing money) but the vast majority of that treasury debt is purchased by holders of US dollars (banks, funds, China, Japan etc.)


Yes, debt issued by the US treasury is funded by private holders of US dollars.

Here's how I think it works:

-In theory, the Federal Reserve targets average inflation of 2% (along with its unemployment mandate)

-When the US government runs a deficit, the government sells bonds and uses the dollars to pay whatever it's paying for

-This process soaks up dollars from investors and gives out dollars to people, which on net lowers investment, increases interest rates, and increases GDP (see IS/LM model: https://en.wikipedia.org/wiki/IS–LM_model)

-The Fed, which aims to stabilize inflation, accommodates the rise in interest rates by setting higher target rates for its open market operations (if they fought the movement in interest rates by buying assets, inflation would rise, which is against their mandate)


How selling bonds soaks dollars from investors?

If you go to a bank and ask for a credit for starting a business, if the bank approve of your project, they will credit your bank account with new money. That money is new created money.

How is that related to more or less bonds sales?


If investors spend their dollars on government bonds, they have fewer dollars to spend on other investments. The lower supply of investor dollars for these investments causes interest rates to rise.

yes, but interest rates help drive supply of money, not the other way around. lower interest rates give cheaper access to capital which drives a higher supply.

All those Princeton and Harvard economists travelling the world telling foreign governments how to run their economy lol. Does any politician in the US even read the emails the Fed sends them? Must be the most thankless job ever.

Interesting use of the Smiler RollerCoaster in the lead photo. It was involved in a serious crash a few years ago.

Is this a result (in part or more) of setting a schedule for fed funds rate increases and sticking to it?

Based on past patterns, we now have about 15 months before a formal recession is declared. This is rough and imperfect, but many other metrics are pointing to both the end of the bull market and a coming recession. I've been monitoring the econ because I plan to invest in real-estate and stocks during the next slump. [Corrected "bear" typo.]

>"I've been monitoring the econ because I plan to invest in real-estate and stocks during the next slump."

Which raises the question of "isn't every other investor?" And if that's the case, how much of that has the market already factored into pricing?

For example, I hear a lot of people in the Bay Area talking about saving up for when the next crash occurs so they can buy real estate cheap. But if there's sufficient pent up demand and capital, that can dampen the impact like what appears to have happened with the 2008 recession[1], only perhaps magnified after this bull run.

[1] https://www.bayareamarketreports.com/trend/3-recessions-2-bu...


Going back roughly 4 decades, the best time to buy real-estate for investment has been during or just after recessions. Have investors changed after those four decades? If by chance real-estate doesn't go down during the next slump, then perhaps stocks will; I got choice. It's unlikely that neither will shift downward, and I might skip investing if both stay high.

Interest rates on constructed real-estate is also lower during slumps. Of course investors could be wrong, it happens. But buy-low-sell-high has on average worked best. It's one of Warren Buffett's key strategies (although arguable he is buy-low-and-keep).


Keep in mind the next recession may very well not have anything to do with real estate. We also just went through a prolonged period of record low interest rates during which you could finance real estate really cheaply (though prices could have been inflated from excess demand, but [a] I'm no real estate expert and [b] this could vary significantly from location to location).


* the end of the bull market
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