5 votes

(Don't fear) the yield curve, reprise

5 comments

  1. [5]
    HotPants
    Link
    Their Summary: The yield curve is important, but it hasn't inverted fully yet, so don't freak out just yet. And even if it does invert, this time might be different. My Summary: When the yield...

    Their Summary: The yield curve is important, but it hasn't inverted fully yet, so don't freak out just yet. And even if it does invert, this time might be different.

    My Summary: When the yield curve fully inverts (all longer term US treasuries pay a lower rate of interest) the market expects another recession in a years time. But a full inversion might not happen for another year. So we are probably fine for a while?

    My Detail:
    We are about to see an increase in the chatter around yield curve inversion.

    You can see the current yield curve here or here. Currently treasury bills have a steep yield curve, where as bonds and notes are flat/slightly inverted.

    Typically the Federal Reserve looks at 3 month vs 10 year yield differences to predict recessions and gdp growth. This is not even close to inverting yet.

    It's worth noting however, that the 2 year vs 10 year yield has successfully predicted 9 out of the last 8 recessions. This just inverted (blue line went negative).

    And the market is predicting a likely inversion before 2023.

    3 votes
    1. [4]
      skybrian
      Link Parent
      Huh. I would summarize the article this way: There's no reason to look at the 10-2 yield spread when the 2 year-3 month spread predicts better. (All very nice, but I didn't immediately find a...

      Huh. I would summarize the article this way:

      1. There's no reason to look at the 10-2 yield spread when the 2 year-3 month spread predicts better. (All very nice, but I didn't immediately find a graph of this. Shouldn't there be one on FRED?)

      2. This spread is mostly just predicting what the Fed will do. If you have other ways of deciding what the market thinks the Fed will do, the spread doesn't really add anything to it. Treating it as independent evidence is double-counting.

      3. Historical statistics about this are misleading, because there's no way it predicted the pandemic's economic effects far in advance, but statistically it looks like it did.

      2 votes
      1. [3]
        HotPants
        Link Parent
        Typically the Federal Reserve looks at 3 month vs 10 year yield differences to predict recessions and gdp growth. I actually look at the entire yield curve here or here, because typically...

        There's no reason to look at the 10-2 yield spread when the 2 year-3 month spread predicts better. (All very nice, but I didn't immediately find a graph of this. Shouldn't there be one on FRED?)

        Typically the Federal Reserve looks at 3 month vs 10 year yield differences to predict recessions and gdp growth.

        I actually look at the entire yield curve here or here, because typically recessions have a fully inverted yield curve, where the 3 month yields more than the 1 year, and the 1 year yields more than the two year etc....

        This spread is mostly just predicting what the Fed will do. If you have other ways of deciding what the market thinks the Fed will do, the spread doesn't really add anything to it. Treating it as independent evidence is double-counting.

        There are a number of explanations from different economists, some point to the fact that an inverted yield curve means banks are not able to profitably lend money on long term mortgages while funding those mortgages from short term savings accounts (because the savings account pays out more than the mortgage) so loans dry up and that causes a recession. Some point to the fact that everyone wants to hold long term bonds if they predict a recession will hit, because when rates drop, the long term bonds increase significantly in value. Some point to the fact that the federal reserve needs to hike short term rates up higher than long term rates in order to cool off inflation, which inevitably throws the economy into a recession. While the fed controls the fed fund rates and the reserve ratio required at banks, the market determines rates for 3 months through to 30 years, so the yield curve doesn't really predict what the federal reserve will do, more than it predicts what the federal reserve will do to the fed funds rates in response to any recession (lower the fed funds rates and buy more long term bonds using operation twist etc.)

        Historical statistics about this are misleading, because there's no way it predicted the pandemic's economic effects far in advance, but statistically it looks like it did.

        The pandemic was interesting. The fed aggressively lowered rates due to the pandemic in anticipation of a recession, so there is no telling if a recession would have happened anyway even without the pandemic. There have been some valid criticisms about the fact that the inverted yield curve never predicts anything in other countries. Australia had an inverted yield curve for a number of years, and nothing happened. But American dollars often denominates foreign loans, the exchange rate drives oil costs in other countries, and being the reserve currency does make American interest rates often the driver for other countries interest rates. That last bit is my 2c, not something I have seen echoed from economists, so I could be off base there.

        1 vote
        1. [2]
          skybrian
          (edited )
          Link Parent
          I have no strong opinion here. I was just loosely summarizing what the authors of the article seem to be claiming. I think so many things are correlated and interconnected that predicting the...

          I have no strong opinion here. I was just loosely summarizing what the authors of the article seem to be claiming.

          I think so many things are correlated and interconnected that predicting the future doesn't work very well. Without a crystal ball to tell you about important economic events in advance (for example the pandemic, its effects on supply chain issues, and the Ukraine invasion), you're always going to be off. And even if you did know about these things, the market's reaction to them isn't all that predictable either.

          1 vote