Yield Curve Inverting

[orthopa]

I think its common investor knowledge that an inverted yield curve seems to almost always precede a recession. Time to recession from what I gather can be 5-18 months on average. Yet another sign that we are late to very late cycle. Anyone preparing or shifting the portfolio around at all? Of course market timing is impossible but it maybe prudent to start to accumulate some cash going forward or sell some high flying stuff. Something as simple as lightening up 5-10% a month would get you into a high cash position.

 

Ofcourse one would have to account for taxes/investment period etc but in a retirement or tax advantaged account this maybe a strategy. Fear would be missing out on some gains but it seem like we are much closer to the top then the bottom at his time.

 

I was too young wasn't investing as actively when yield curve inverted last time but sure would have like to have a higher percentage of cash in the 12-18 months following 2007.

[StubbleJumper]

I'm not sure that I would get too jumpy about the yield curve.  It's not exactly inverted, even if a couple of journalists decided to make a bit of hay from the two-year being a shade higher then the five-year:

 

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

 

 

It might end up fully inverting, but the morning the only rate relationships that were "wrong" is that the 2-year yields 2.82% and the 5-year 2.81%.  Not a panic just yet, imo.

 

 

SJ

[Guest Schwab711]

I've always heard about inverted yield curves being bad too. I checked if the curve was inverted at any portion for each trading day between 1990 and June 2018 (data I had on hand). In 26.7%, or roughly 2 out of every 7, trading days had an inverted yield curve, at some point on the curve.

[nickenumbers]

I would like you smart people to put the concept of an inverted yield curve into 1 Banana terms.

1 Banana= easy/simple

2 Banana= challenging

3 Banana= makes a monkey wanna scream cause it is so damn hard

 

Einstein said that the Order of Intelligence in ascending order is "smart, intelligent, brilliant, genius, SIMPLE."  Reducing the complex to simple is BEAUTIFUL!!

 

 

I know what an inverted yield curve is...  but there are lots of ways to think about it.

 

Does it mean that there is no demand for 2 yr debt because everyone is in cash, and the result is that prices of 2 yr debt have gone down and yields have gone up?

 

[My explanation is kinda wordy, and probably not the best characterization.]

 

 

Give this Monkey a 1 banana explanation.  Thanks.

[Jurgis]

Give this Monkey a 1 banana explanation.  Thanks.

 

I prefer a banana over a banana explanation.  8)

[SHDL]

Give this Monkey a 1 banana explanation.  Thanks.

 

I do have a relatively simple (and to my knowledge correct) explanation.  It does require 3 bananas, unfortunately, but the good news is that you only have to finish one at a time. 

 

Anyway:

 

First banana:  When a recession hits, central banks tend to reduce (short term) interest rates.  Their intent is to stimulate economic activity by doing so.

 

Second banana:  People anticipate the above, and so when they think a recession is coming, they expect interest rates to go down in the near future. 

 

Third banana:  When people expect interest rates to go down in the future, long term bond yields tend to decline in relation to short term yields.  This is just DCF math.

 

By putting these pieces together you should be able to see why yield curves tend to invert when people expect a recession is coming. 

[Guest cherzeca]

I like grannis' work on this:  http://scottgrannis.blogspot.com/2018/11/the-yield-curve-is-not-forecasting.html

[Cigarbutt]

I like grannis' work on this:  http://scottgrannis.blogspot.com/2018/11/the-yield-curve-is-not-forecasting.html

I like his work too, possibly because his ideas offer a different (and opposite) perspective.

 

Sometimes interesting to look back:

http://scottgrannis.blogspot.com/2014/12/gloomy-yield-curve.html

The first chart is fascinating because it appears that the gloomy market had it pretty much right in terms of the forward looking yield curve.

 

Mr. Grannis needs to be thanked because, reading his thoughful analyses, one could learn the meaning of the word: transmogrify

Over the years, Mr. Grannis has been expecting (and he still does) the economy to transform like a caterpillar becoming a butterfly.

But the word really has a much more of a colorful meaning: transform, especially in a surprising or magical manner.

As in: "the cucumbers that were ultimately transmogrified into pickles".

Who remembers what happened to Cinderella at midnight?

[rb]

I'm not sure that I would get too jumpy about the yield curve.  It's not exactly inverted, even if a couple of journalists decided to make a bit of hay from the two-year being a shade higher then the five-year:

 

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us

 

 

It might end up fully inverting, but the morning the only rate relationships that were "wrong" is that the 2-year yields 2.82% and the 5-year 2.81%.  Not a panic just yet, imo.

 

 

SJ

Maybe it's not fully inverting. But it's flat as hell!

[rb]

Give this Monkey a 1 banana explanation.  Thanks.

 

I do have a relatively simple (and to my knowledge correct) explanation.  It does require 3 bananas, unfortunately, but the good news is that you only have to finish one at a time. 

 

Anyway:

 

First banana:  When a recession hits, central banks tend to reduce (short term) interest rates.  Their intent is to stimulate economic activity by doing so.

 

Second banana:  People anticipate the above, and so when they think a recession is coming, they expect interest rates to go down in the near future. 

 

Third banana:  When people expect interest rates to go down in the future, long term bond yields tend to decline in relation to short term yields.  This is just DCF math.

 

By putting these pieces together you should be able to see why yield curves tend to invert when people expect a recession is coming.

Let me see if I can build on that and try to take it down to a 2 banana.

 

You can think of a rate for a period as a collection of rates for smaller periods. So a 3 year rate is actually 3 1 year rates: a one year rate from 0 to 1, a one year rate from 1 to 2 and a one year rate from 2 to 3.

 

The fed lower rates during bad economic times. So let's say you have an inverted yield curve. Say in my example above the 3 year rate would be lower than the 1 year rate. That means that unless the market is wrong the 1 year rate in year 2 or 3 or both will be lower than the current 1 year rate. Which further implies that the economy will be doing less good than it does now. So an inverted yield curve it's a bad omen.

[meiroy]

I like grannis' work on this:  http://scottgrannis.blogspot.com/2018/11/the-yield-curve-is-not-forecasting.html

 

Yes, he's fantastic. He does have two strong biases, though: 1. he's 100% supply side, everything begins and ends with that.  2. he doesn't really get China's economy and its real impact on the U.S. economy. 

 

 

"In any event, it's possible, and likely, that good news on the global trade front could alter the bond market's expectations rather dramatically, resulting in a steeper yield curve and ultimately a stronger economy. "

 

China/USA issues are not going to be resolved any time soon.

 

Having said that, he does post clear data which is quite useful.

 

I'm betting that if there's a real panic starting the Fed will not raise until things calm down, if not next time then the one that follows.

 

 

[nickenumbers]

Great info and answers everyone.  Thank you.  I have started to read thru Scott Grannis's blog postings, etc.  Great info.

 

I am a banana eating monkey, and I am getting smarter by the day!

[Cigarbutt]

Great info and answers everyone.  Thank you.  I have started to read thru Scott Grannis's blog postings, etc.  Great info.

 

I am a banana eating monkey, and I am getting smarter by the day!

One has to wonder how much of available time should be spent on this (less than 5%?).

 

Some of the blog postings have more value.

Over time, the author has shown the ability to change opinions with changing facts which is good but also has evolved his narrative despite facts which is more concerning but don't we all do that?

 

Here are two samples to reflect upon:

http://scottgrannis.blogspot.com/2016/08/qe-and-amazing-demand-for-money.html

This post corresponds to the feed the pigs cartoon shown elsewhere when discussing QE.

People say it's more difficult to lose weight to offset the gain and there's the yo-yo effect.

 

http://scottgrannis.blogspot.com/2009/07/money-velocity-is-likely-stabilizing-4.html

This post deals with money velocity. The author has always believed that the most important factor consisted in finally adopting a risk-seeking attitude (?!) and unleashing animal spirits in order to stimulate fixed investment and increase real productivity so that the yield curve could steepen and we could all live happy forever after. Interestingly, the Fairfax team has somewhat equivocally espoused that thesis too.

Recently, the market has refused to cooperate and maybe it's time for a different tone (tune?).

 

Please continue yor banana learning and show old monkeys new tricks.

[Cigarbutt]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

[Spekulatius]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

[Cigarbutt]

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

If indeed the Fed starts to lower rates, it means we never really left the accommodative phase. Uncharted waters.

[rb]

Wrong! It's been chartered before. See 1937. History helps.

[Cigarbutt]

Wrong! It's been chartered before. See 1937. History helps.

The 1937 period is interesting, isn't it?

But "I don't know how we get out of this":

https://www.cnbc.com/2015/04/11/druckenmiller-this-could-end-very-badly.html

 

Charter: a document issued by some authority

Chart: some kind of map

 

If things get rough at this point, I'd rather have a map.

[TwoCitiesCapital]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

 

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

[meiroy]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

 

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

 

Reflexivity.  In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad.  The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown.

 

The big unknown here is not the Fed, it's Trump.  He called an emergency on the wall. He just nominated someone to the Fed that no doubt he believes will support his views. What else is he willing to do for us to get a happy dead cat bounce?  That's my bet, it's not going straight down from here.  We will have fun first.

 

 

 

[Spekulatius]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

 

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

 

Reflexivity.  In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad.  The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown.

 

The big unknown here is not the Fed, it's Trump.  He called an emergency on the wall. He just nominated someone to the Fed that no doubt he believes will support his views. What else is he willing to do for us to get a happy dead cat bounce?  That's my bet, it's not going straight down from here.  We will have fun first.

 

Trump regards the stock market as an important scorecard. We have heard this in the news occasionally and Kohn explicitly confirmed this in the Freakonomics podcast that I posted. While none knows the future, I  think there is a high probability that the next economic crisis will be caused by a political crisis, as a fallout from the populist movements prevalent in many countries, not just the US. We might see a case of this with Brexit in the UK.

 

As for the Fed, I think people have an exaggerated sense of its impact on the economy and it’s power to control its path. As an investor for quite some time, I can only say that when the pundits put their hope into the feds bailing out the market, we were typically in for a rough time.

 

As for the yield curve, I think we might have imported this basically from Europe. Europe has no negative interest rates almost as far as the eye can see in some countries, so a 2.5% interest for a 10 year treasury may actually look pretty juicy as strange as that may sound. I am not sure what he Fed can do about this either.

[Cigarbutt]

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

Reflexivity.  In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad.  The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown.

...

...  That's my bet, it's not going straight down from here.  We will have fun first.

As for the Fed, I think people have an exaggerated sense of its impact on the economy and it’s power to control its path. As an investor for quite some time, I can only say that when the pundits put their hope into the feds bailing out the market, we were typically in for a rough time.

...

I agree that the Fed may become irrelevant but they have been a major driver behind valuations. I would say they have a very difficult (impossible?) mandate, given built-in expectations and circumstances.

-----

Continue reading if you have a PhD in physics, have an interest in aeronautics (Boeing issues) and if you have two minutes to spare.

It seems that the crowd is expecting the Fed to do an aileron roll.

What is fascinating about this acrobatic maneuver is that the plane ends up at the same altitude it started while benefitting from increased pitch and greater angle of attack, enabling the wings to generate lift when the airplane is completely inverted.

While watching these shows in awe, I always wonder what the downside risks are.

-----

Back to investing.

[rkbabang]

While watching these shows in awe, I always wonder what the downside risks are.

 

http://www.defenseworld.net/uploads//news/big/mirage-v__1476787129.jpg

[John Hjorth]

...

-----

Back to investing.

 

Cigarbutt,

 

Somehow I'll argue, that the bullet #1 in the Youtube video : - "Slight nose up attitude" - certainly has merit in the current investment environment, -but not exactly meant the way mentioned in the video ... - more conceptually meant with reference to Icarus, Hubris & Nemesis. [ ; - ) ]

 

- - - o 0 o - - -

 

Today, I've been bear hugging my NVO dividends just received.

 

- - - o 0 o - - -

 

On a more serious note: In short, I share Spekulatius' view, expressed above. Likely rough times ahead for us. Personally, I just hope that we this year get at least some satisfactory clarity on the situation going forward with regard to Brexit & ongoing trade disputes. This may however still be too much to ask or hope for.

[TwoCitiesCapital]

Yields are getting horizontal and who knows what that means?

Bias: in another life a flatline meant efforts for resuscitation and it seems that the FED may be getting ready to do just that as they recently surveyed primary dealers on how to fine-tune the management of rates.

 

A lingering thought is that successful resuscitation is generally unlikely and is inversely related to the length of time spent attempting resuscitation. At least, that's what Wikipedia says.

 

I personally can’t tell what is a symptom and what is the disease, but I tend to think of inverting interest rate as a symptom.

 

Just my opinion, but every time, investors put their hope into Fed, they tend to get disappointed. I suspect the market will take a real dump, if indeed the Fed starts to lower rates.

 

I think it can be be both right? At first it's a symptom - it's markets being concerned about future growth/inflation and predicting a rate cut; however, it can also become self-fulfilling and contribute to the slowdown because the inversion strangles credit supply further slowing the economy

 

Reflexivity.  In this case, there are definitely fundamental issues regardless of expectations. Rising rates would have a serious impact, no matter how they do it, the only question is how bad.  The method the Fed uses makes things worse, because, well, they are clueless as the past few months have shown.

 

The big unknown here is not the Fed, it's Trump.  He called an emergency on the wall. He just nominated someone to the Fed that no doubt he believes will support his views. What else is he willing to do for us to get a happy dead cat bounce?  That's my bet, it's not going straight down from here.  We will have fun first.

 

Agreed. It's never straight down. There are always bounces along the way until the buy-the-dip mentality is sufficiently beaten to death.

 

It's why I didn't sell/short on the way down in December, but was selling/shorting/buying bonds after the incredible bounce in January.

 

This was an opportunity to reduce risk after markets have confirmed the bear market. Not an opportunity to buy the dip.