yield curve inversion

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privatefarmer
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yield curve inversion

Post by privatefarmer » Wed Jul 04, 2018 12:24 am

wondering what is everyone's thoughts on "yield curve inversion"? Heard of the concept via Wes Moss's radio show, who I admit is not exactly a financial guru but rather an entertainer who mostly spreads garbage about the financial markets. However, he notes that typically long-term gov. bonds yield more than short-term (duh) but when short term bonds yield higher than long-term (which apparently they have in rare instances) this is a definitive sign of an upcoming recession. I don't buy it, personally. I think maybe this has happened in the past but I don't buy that there is ANY definitive way to predict future recessions. The market simply is not predictable and if it were all the big money would get out oat the exact right time.

Currently, long-term gov bonds yield ~3% and short-term ~2%, he is saying that if long-term bonds were to yield say 2% and short-term yielding 2.5% then a recession is coming.

Anyhow would love to hear others' opinions on "yield curve inversion", or if anyone just wants to join the "bash Wes Moss" bandwagon please chime in ;)

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Re: yield curve inversion

Post by drk » Wed Jul 04, 2018 12:56 am

Your take is spot-on: there is no such thing as "definitive" there, except in the broken clock sense. If you're curious to read more about the fears, here's Ben Carlson's take in Bloomberg View (from December) and an explainer in the New York Times. From that last one:
Every recession of the past 60 years has been preceded by an inverted yield curve, according to research from the San Francisco Fed. Curve inversions have “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession,” the bank’s researchers wrote in March.
As always, the problem is when. Bloomberg has had several articles about concerned traders over the last year.

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Re: yield curve inversion

Post by Beensabu » Wed Jul 04, 2018 12:59 am

"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next."

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Re: yield curve inversion

Post by ralph124cf » Wed Jul 04, 2018 10:04 am

It is certainly true that there is a correlation. There does not appear to be good, testable theory as to why one would cause the other.

Correlation does not imply causation.

Ralph

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Re: yield curve inversion

Post by nisiprius » Wed Jul 04, 2018 10:07 am

I have an impression that the definition of "inverted yield curve" is constantly refined, adjusted, and modified on the no true Scotsman principle. That is, if the yield curve inverts and no recession follows, it wasn't truly inverted.
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Re: yield curve inversion

Post by balbrec2 » Wed Jul 04, 2018 10:16 am

I think we can look at an inverted yield curve as a heads up.
Something is askew, but exactly what or when remains to be seen.

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Re: yield curve inversion

Post by triceratop » Wed Jul 04, 2018 10:21 am

nisiprius wrote:
Wed Jul 04, 2018 10:07 am
I have an impression that the definition of "inverted yield curve" is constantly refined, adjusted, and modified on the no true Scotsman principle. That is, if the yield curve inverts and no recession follows, it wasn't truly inverted.
Yield curve inversion is a very clear technical description; it's hard to imagine the definition being mushy enough to allow for significant shifting. Do you have evidence backing the impression that the definition is shifting?
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Re: yield curve inversion

Post by corn18 » Wed Jul 04, 2018 10:25 am

ralph124cf wrote:
Wed Jul 04, 2018 10:04 am
It is certainly true that there is a correlation. There does not appear to be good, testable theory as to why one would cause the other.

Correlation does not imply causation.

Ralph
I agree. And right now, we're not flat but flattening and certainly not inverted like 2001 or 2008.

Image

Image

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Re: yield curve inversion

Post by feh » Wed Jul 04, 2018 10:28 am

balbrec2 wrote:
Wed Jul 04, 2018 10:16 am
I think we can look at an inverted yield curve as a heads up.
Something is askew, but exactly what or when remains to be seen.
+1

I am not a market timer, but I am keeping an eye on the 2/10 year spread.

https://ycharts.com/indicators/210_year ... eld_spread

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Re: yield curve inversion

Post by nisiprius » Wed Jul 04, 2018 11:55 am

triceratop wrote:
Wed Jul 04, 2018 10:21 am
nisiprius wrote:
Wed Jul 04, 2018 10:07 am
I have an impression that the definition of "inverted yield curve" is constantly refined, adjusted, and modified on the no true Scotsman principle. That is, if the yield curve inverts and no recession follows, it wasn't truly inverted.
Yield curve inversion is a very clear technical description; it's hard to imagine the definition being mushy enough to allow for significant shifting. Do you have evidence backing the impression that the definition is shifting?
OK. I'm guilty of cynical exaggeration. You're right. But I'm not totally off, it does not have all that clear a definition.

I've just been Googling.

The majority of definitions that pop up simply say vague things like

"An inverted yield curve occurs when long-term yields fall below short-term yields."
"An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality."
"An inverted yield curve is when the yields on bonds with a shorter duration are higher than the yields on bonds that have a longer duration."
"Inverted yield curve: When short-term interest rates are higher than long-term rates."

Those definitions are mushy. Exactly what counts as long-term and what counts as short-term? Why not name the number of years? How do we average or otherwise combine plural "rates?" Without that, how can we say if this was an "inverted yield curve" or not?
Image
3 month 4.90%
2 year, 4.88%
5 year, 4.82%
7 year, 4.83%
10 year, 4.88%
20 year, 5.09%
30 year, 5.01%
The thirty-year bond had a higher rate than the 3-month bill, so it was not inverted.
The ten-year bond had a lower rate than the 3-month bill, so it was inverted.

Now, I read: "A truly inverted yield curve is a pretty powerful predictor of a recession or for economic performance," so there is that word "truly." How do we know if the yield curve is "truly" inverted or "a little inverted but not 'truly' inverted?"

In one of his books, Ken Fisher notes that "A truly inverted yield curve is rare and has a reputation for being bearish." So there is that word "truly" again, and he goes on for a number of pages on his theories about why a "truly" inverted yield curve doesn't necessarily predict a bear market, and why you have to apply his macroeconomic understanding because international yield curves might more powerful than US yield curves in predicting US bear markets, etc.

Now, almost everyone seems to cite a Ph.D. thesis by Campbell R. Harvey, "Recovering Expectations of Consumption Growth from an Equilibrium Model of the Term Structure of Interest Rates" as a key paper about inverted yield curves. It's available here so I looked at it to see if there was a precise definition there. I'm not sure if I found it or not. Is "the" definition of a an inverted yield curve "a negative value of Harvey's 'spread variable?'"
The real interest rate variable is a one year corporate bond yield. The spread variable is constructed by taking the natural logarithm of the ratio of the one year corporate yield and the yield on 30–60 day Commercial paper (1900–1919) and 90 day Treasury Bills (1920–1984). The second panel shows the annual data for the 1953–1984 period. The interest rate variable in this sub-period is the rate on a one year government bond. The spread is constructed with the yields on two government instruments. This sample is the more reliable than the longer period because the government instruments are available and because this sub-period follows the Treasury–Federal Reserve Accord.
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Re: yield curve inversion

Post by Sidney » Wed Jul 04, 2018 12:16 pm

I have no idea whether an inverted curve has any predictive value but your OP mixes in "recession" and "the market." Which were you most concerned about?
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Re: yield curve inversion

Post by Kenkat » Wed Jul 04, 2018 12:18 pm

balbrec2 wrote:
Wed Jul 04, 2018 10:16 am
I think we can look at an inverted yield curve as a heads up.
Something is askew, but exactly what or when remains to be seen.
And furthermore, whatever it is that is askew, there’s probably not a lot, if anything, you can do about it

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Re: yield curve inversion

Post by bikechuck » Wed Jul 04, 2018 1:08 pm

I am convinced that IF the future resembles the past and if the yield curve inverts we will likely have a recession. From everything that I have read there is a strong correlation between these two events.

The next question is what you should do in the event of a recession. I believe that the best answer to that question is do nothing and stay the course.

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Re: yield curve inversion

Post by nisiprius » Wed Jul 04, 2018 1:14 pm

With regard to predicting recessions, it should be noted that the National Bureau of Economic Research not only will not try to predict a recession, it will not even go on record as say that there is a recession until after it is over.

Of course, another detail is that we do not have an inverted yield curve.
Dynamic yield curve
Image
One of my personal rules is that any prediction can probably be ignored, but chains of more than one prediction can definitely be ignored. In this case there might even be a three-prediction parlay:

1) There is only a prediction that the yield curve will invert.
2) When the yield curve inverts, that predicts a recession.
3) A recession predicts a bear market.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: yield curve inversion

Post by triceratop » Wed Jul 04, 2018 1:21 pm

The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term. More generally I suppose one could look at the yield curve of other asset classes.

Quoting one paragraph from a PhD thesis devoid of context is unlikely to produce understanding. The quoted passage also has nothing to do with term structure.

It is also true that if you google the word "truly" in associated with yield curve inversion search parameters, you will find various hand-wringing seeking to explain why it has failed as a macroeconomic indicator. Of course, that is unrelated to the actual definition.
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Re: yield curve inversion

Post by Mountain Doc » Wed Jul 04, 2018 2:14 pm

triceratop wrote:
Wed Jul 04, 2018 1:21 pm
The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term. More generally I suppose one could look at the yield curve of other asset classes.

Quoting one paragraph from a PhD thesis devoid of context is unlikely to produce understanding. The quoted passage also has nothing to do with term structure.

It is also true that if you google the word "truly" in associated with yield curve inversion search parameters, you will find various hand-wringing seeking to explain why it has failed as a macroeconomic indicator. Of course, that is unrelated to the actual definition.
I doubt Nisi is really contesting the technical definition of an inverted yield curve, but instead pointing out how advocates for the predictive power of an inverted yield curve explain away yield-curve inversions that don't end up predicting a recession. For example, on 7/25/17 the yield on the 13 week and 26 week bills closed at 1.18% and 1.15%, respectively. No recession followed. Those advocates would likely respond that this wasn't a significant enough inversion to matter. Thus, the question is raised, how inverted does the yield curve have to be to be predictive of recession? The squishiness of this answer allows prognosticators to move the goalpost in support of their theory.

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Re: yield curve inversion

Post by corn18 » Wed Jul 04, 2018 2:23 pm

Having a hard time seeing that as an inversion, but whatevs.

Image

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Re: yield curve inversion

Post by triceratop » Wed Jul 04, 2018 2:30 pm

Mountain Doc wrote:
Wed Jul 04, 2018 2:14 pm
triceratop wrote:
Wed Jul 04, 2018 1:21 pm
The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term. More generally I suppose one could look at the yield curve of other asset classes.

Quoting one paragraph from a PhD thesis devoid of context is unlikely to produce understanding. The quoted passage also has nothing to do with term structure.

It is also true that if you google the word "truly" in associated with yield curve inversion search parameters, you will find various hand-wringing seeking to explain why it has failed as a macroeconomic indicator. Of course, that is unrelated to the actual definition.
I doubt Nisi is really contesting the technical definition of an inverted yield curve, but instead pointing out how advocates for the predictive power of an inverted yield curve explain away yield-curve inversions that don't end up predicting a recession. For example, on 7/25/17 the yield on the 13 week and 26 week bills closed at 1.18% and 1.15%, respectively. No recession followed. Those advocates would likely respond that this wasn't a significant enough inversion to matter. Thus, the question is raised, how inverted does the yield curve have to be to be predictive of recession? The squishiness of this answer allows prognosticators to move the goalpost in support of their theory.
That may very well be but he seemed reasonably clearly contesting the definition in the post to which I replied.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: yield curve inversion

Post by Mountain Doc » Wed Jul 04, 2018 2:37 pm

triceratop wrote:
Wed Jul 04, 2018 2:30 pm
That may very well be but he seemed reasonably clearly contesting the definition in the post to which I replied.
Fair enough, I will let the two of you duke it out :D

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Re: yield curve inversion

Post by stlutz » Wed Jul 04, 2018 2:43 pm

Yield curve inversion is a very clear technical description; it's hard to imagine the definition being mushy enough to allow for significant shifting. Do you have evidence backing the impression that the definition is shifting?
I think back in the olden days everybody would compare the 3 month T-bill to the 10 year treasury.

More recently, the 2 year/10 years spread seems to have become the favored measuring stick.

Currently, the later is much closer to inverting than the former.

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Re: yield curve inversion

Post by patrick013 » Wed Jul 04, 2018 3:28 pm

To buy or sell anything you need the buyer and seller
to agree on the price. The market may think the rate
increases are short lived. Will the FFR 5 years from
now be 1% or 3%. If 1% why sell bonds with a 3% YTM ?
If 3% buyers may demand TRSY 10 at 4% or higher, or just
not buy. The greater the perception the rates are short
lived the greater the chance for an inversion as short rates
respond higher but longer term spreads do not respond to
current FFR rates.

Plus strong demand is keeping most bond yields a little
lower than they could be.

Low rates in general have stimulated bond issuances since
2010. Point is the corporate bond market has an ample supply
of debt outstanding making that market well supplied with
quality debt for sale at very good credit premiums over TRSY.
age in bonds, buy-and-hold, 10 year business cycle

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Re: yield curve inversion

Post by triceratop » Wed Jul 04, 2018 3:35 pm

stlutz wrote:
Wed Jul 04, 2018 2:43 pm
Yield curve inversion is a very clear technical description; it's hard to imagine the definition being mushy enough to allow for significant shifting. Do you have evidence backing the impression that the definition is shifting?
I think back in the olden days everybody would compare the 3 month T-bill to the 10 year treasury.

More recently, the 2 year/10 years spread seems to have become the favored measuring stick.

Currently, the later is much closer to inverting than the former.
My definition encapsulates both :)
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Re: yield curve inversion

Post by Kevin M » Wed Jul 04, 2018 4:07 pm

triceratop wrote:
Wed Jul 04, 2018 1:21 pm
The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term.
I don't know if this is true or not (can you cite a source?), but let me see if I can even parse what you're saying. First, translating the double negative "are not ... nondecreasing", I think means "are increasing or flat". And monotonically increasing or flat means that yield increases or is flat as term to maturity increases.

So between no two adjacent terms does yield increase. In other words, 1-month to 3-month is flat or decreasing, 3-month to 6-month is flat or decreasing, ..., 20-year to 30-year is flat or decreasing.

We can evaluate this and its relationship to recessions to some extent using FRED constant maturity Treasury (CMT) yields, but one problem is that the yield history is more limited for some terms than for others. For example, 10-year CMT is available since April 1953, but 2-year CMT is available only since Jun 1976.

Using just the 10-2, we see this:

Image

When the curve drops below 0, the yield curve between 2-year and 10-year maturity is inverted. Using this measure, the yield curve did always invert before a recession, but sometimes quite awhile before, and in 3 out of 5 receissions, it had uninverted before the recession officially started.

Kevin
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Re: yield curve inversion

Post by Mountain Doc » Wed Jul 04, 2018 4:10 pm

corn18 wrote:
Wed Jul 04, 2018 2:23 pm
Having a hard time seeing that as an inversion, but whatevs.

Image
Your slightly more lax view on what constitutes an inversion, when contrasted with Triceratop’s strict view, perhaps is an example of what Nisi was trying to say about definitions.

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Re: yield curve inversion

Post by stlutz » Wed Jul 04, 2018 4:12 pm

When the curve drops below 0, the yield curve between 2-year and 10-year maturity is inverted. Using this measure, the yield curve did always invert before a recession, but sometimes quite awhile before, and in 3 out of 5 receissions, it had uninverted before the recession officially started.
A question partially raised by another thread that's going on now as well. Is there any suggestion that inverting the curve *causes* a recession to occur? Or would the claim simply be that long-term rates tend to be a little "smarter" in economic forecasting than short term rates (and by extension, the Federal Reserve)?

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Re: yield curve inversion

Post by Doc » Wed Jul 04, 2018 5:05 pm

stlutz wrote:
Wed Jul 04, 2018 4:12 pm
A question partially raised by another thread that's going on now as well. Is there any suggestion that inverting the curve *causes* a recession to occur? Or would the claim simply be that long-term rates tend to be a little "smarter" in economic forecasting than short term rates (and by extension, the Federal Reserve)?
I alway thought that the inverted yield curve vs. recession came from looking at a spread chart like Kevin showed. It's just data that has occured in the past. It may or may not be predictive. But in any case I don't think I've seen any cause and effect arguments.
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Re: yield curve inversion

Post by triceratop » Wed Jul 04, 2018 7:43 pm

Kevin M wrote:
Wed Jul 04, 2018 4:07 pm
triceratop wrote:
Wed Jul 04, 2018 1:21 pm
The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term.
I don't know if this is true or not (can you cite a source?), but let me see if I can even parse what you're saying. First, translating the double negative "are not ... nondecreasing", I think means "are increasing or flat". And monotonically increasing or flat means that yield increases or is flat as term to maturity increases.

So between no two adjacent terms does yield increase. In other words, 1-month to 3-month is flat or decreasing, 3-month to 6-month is flat or decreasing, ..., 20-year to 30-year is flat or decreasing.
"are not monotonically nondecreasing" means the logical negation of "everywhere increasing or flat" :). Yes, it's a double negative.

You might also be interested in the term "partial inversion". A fully inverted yield curve is one which is monotonically nonincreasing.
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Re: yield curve inversion

Post by jalbert » Wed Jul 04, 2018 8:11 pm

ralph124cf wrote:
Wed Jul 04, 2018 10:04 am
It is certainly true that there is a correlation. There does not appear to be good, testable theory as to why one would cause the other.

Correlation does not imply causation.

Ralph
Banks borrow at the short end of the yield curve, and lend at the longer end of the yield curve. When the yield curve inverts, it makes it unprofitable to lend. This reduces economic activity. If the yield curve inverts because bond investors fear a recession, the effect on lending makes it even more likely to happen.

But the yield curve also sometimes flattens when the Fed is raising rates. This may become a driver for a recession, or the economy may be strong enough to push intermediate and long rates higher.

So there actually is a causal connection between an inverted yield curve and a recession (in both directions), but it is a probabilistic, not deterministic connection. Time will tell.
Risk is not a guarantor of return.

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Re: yield curve inversion

Post by patrick013 » Thu Jul 05, 2018 1:19 pm

The rate for shorter terms may increase 1% and longer terms
may increase only .5% or even invert. Sellers might not sell
if req'd to raise yields based on a base rate change that just
hasn't happened yet.

Spiking rates can slow business activity. I guess it's an experiment
if raising rates slowly will normalize interest rate markets without
causing a recession. An economy with ultra-low rates is not an
overall good economy.

MHO
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Re: yield curve inversion

Post by feh » Thu Jul 05, 2018 3:08 pm

Thought readers of this thread might be interested:

https://www.marketwatch.com/story/heres ... 2018-07-05

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Re: yield curve inversion

Post by Noobvestor » Fri Jul 06, 2018 9:51 pm

Kevin M wrote:
Wed Jul 04, 2018 4:07 pm
triceratop wrote:
Wed Jul 04, 2018 1:21 pm
The definition of an inverted yield curve is and I think always has been one which credit-riskless instruments (treasury) bear yields which are not monotonically nondecreasing with respect to term.
I don't know if this is true or not (can you cite a source?), but let me see if I can even parse what you're saying. First, translating the double negative "are not ... nondecreasing", I think means "are increasing or flat". And monotonically increasing or flat means that yield increases or is flat as term to maturity increases.

So between no two adjacent terms does yield increase. In other words, 1-month to 3-month is flat or decreasing, 3-month to 6-month is flat or decreasing, ..., 20-year to 30-year is flat or decreasing.

We can evaluate this and its relationship to recessions to some extent using FRED constant maturity Treasury (CMT) yields, but one problem is that the yield history is more limited for some terms than for others. For example, 10-year CMT is available since April 1953, but 2-year CMT is available only since Jun 1976.

Using just the 10-2, we see this:

Image

When the curve drops below 0, the yield curve between 2-year and 10-year maturity is inverted. Using this measure, the yield curve did always invert before a recession, but sometimes quite awhile before, and in 3 out of 5 receissions, it had uninverted before the recession officially started.

Kevin
That's a pretty compelling graphic. And looking at the slope on the right, well, things don't look hot. Anyway, anyone who wants to snapshot (or animate) the yield curve for the past twenty years might find this bookmark handy: http://stockcharts.com/freecharts/yieldcurve.php
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Re: yield curve inversion

Post by corn18 » Sat Jul 07, 2018 7:48 am

Let's say we knew for certain that a recession was going to start in 2021 and last 18 months. What would you do differently than you are now? Sell stocks? Sell Bonds? Go all cash? Doesn't seem to be a good countermeasure to a recession.

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Re: yield curve inversion

Post by grok87 » Sat Jul 07, 2018 8:23 am

For what it's worth the NY Fed apparently uses the 10 yr treasury - 3 month tbill as a recession predictor
https://www.newyorkfed.org/medialibrary ... ob_Rec.pdf
here is the backup
https://www.newyorkfed.org/research/cap ... ycfaq.html
currently model says 12.5% chance of recession starting in June 2019

it's a probit model. you can do it yourself in excel.

Prob of recession 12 months ahead = NORMSDIST(-0.5333-0.63*SPREAD)

where SPREAD = "10 year treasury yield" - "3 month tbill yield" in percentage points. so enter 0.97 not 0.0097 when the spread is 97 bps.

where 10 year treasury yield is the Constant Maturity yield
where 3 month tbill yield is the constant maturity yield adjusted to a bond equivalent basis. which basically involves adding about 3 bps.

June number for the spread was 97.4 bps.

if the spread goes to 0, the probability of recession rises to 30%
if it goes to -1% the probability rises to 54%.

cheers,
grok
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Re: yield curve inversion

Post by grayfox » Sat Jul 07, 2018 9:04 am

grok87 wrote:
Sat Jul 07, 2018 8:23 am
For what it's worth the NY Fed apparently uses the 10 yr treasury - 3 month tbill as a recession predictor
https://www.newyorkfed.org/medialibrary ... ob_Rec.pdf
here is the backup
https://www.newyorkfed.org/research/cap ... ycfaq.html
currently model says 12.5% chance of recession starting in June 2019

it's a probit model. you can do it yourself in excel.

Prob of recession 12 months ahead = NORMSDIST(-0.5333-0.63*SPREAD)

where SPREAD = "10 year treasury yield" - "3 month tbill yield" in percentage points. so enter 0.97 not 0.0097 when the spread is 97 bps.

where 10 year treasury yield is the Constant Maturity yield
where 3 month tbill yield is the constant maturity yield adjusted to a bond equivalent basis. which basically involves adding about 3 bps.

June number for the spread was 97.4 bps.

if the spread goes to 0, the probability of recession rises to 30%
if it goes to -1% the probability rises to 54%.

cheers,
grok
Good Information.

Doesn't the Federal Reserve set short-term interest rates? Can the Fed cause the 3-month T-Bill rate to go up higher than the 10-year Treasury and trigger a recession? Is that something that is within their power?

I recall a guy on the radio used to to say that Fed Chairman Alan Greenspan (a..k.a. The Maestro) was the most powerful man in the world.

grok87
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Re: yield curve inversion

Post by grok87 » Sat Jul 07, 2018 9:53 am

grayfox wrote:
Sat Jul 07, 2018 9:04 am
grok87 wrote:
Sat Jul 07, 2018 8:23 am
For what it's worth the NY Fed apparently uses the 10 yr treasury - 3 month tbill as a recession predictor
https://www.newyorkfed.org/medialibrary ... ob_Rec.pdf
here is the backup
https://www.newyorkfed.org/research/cap ... ycfaq.html
currently model says 12.5% chance of recession starting in June 2019

it's a probit model. you can do it yourself in excel.

Prob of recession 12 months ahead = NORMSDIST(-0.5333-0.63*SPREAD)

where SPREAD = "10 year treasury yield" - "3 month tbill yield" in percentage points. so enter 0.97 not 0.0097 when the spread is 97 bps.

where 10 year treasury yield is the Constant Maturity yield
where 3 month tbill yield is the constant maturity yield adjusted to a bond equivalent basis. which basically involves adding about 3 bps.

June number for the spread was 97.4 bps.

if the spread goes to 0, the probability of recession rises to 30%
if it goes to -1% the probability rises to 54%.

cheers,
grok
Good Information.

Doesn't the Federal Reserve set short-term interest rates? Can the Fed cause the 3-month T-Bill rate to go up higher than the 10-year Treasury and trigger a recession? Is that something that is within their power?

I recall a guy on the radio used to to say that Fed Chairman Alan Greenspan (a..k.a. The Maestro) was the most powerful man in the world.
thanks.
your questions are interesting ones.
Conventional wisdom used to be that the fed only controlled short term rates, 3 month tbill as you say.
but with quantitative easing the 10 year treasury was influenced by the fed as well, at least arguably so.
but then there is Goodhardts law
https://en.wikipedia.org/wiki/Goodhart%27s_law
philosophically if the SPREAD becomes something that is targeted, controlled or managed that may make it less useful as a predictor.
Keep calm and Boglehead on. KCBO.

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grayfox
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Re: yield curve inversion

Post by grayfox » Sat Jul 07, 2018 10:13 am

Looking at this chart, it seems like almost every recession since 1954 was proceeded by the Fed Funds Rate increasing.

Image
FRED: Effective Federal Funds Rate

Recession of:

1957-58: Tight monetary policy
1960-61: Another monetary recession
1969-70: Fiscal Tightening and monetary tightening
1973-75: OPEC oil crisis
1980: Volcker raised interest rates to fight inflation
1981-82: 1979 Iran Revolution caused energy crisis. Tight monetary policy to control inflation.
1990-91: oil price shock. This looks like an exception, rates had fallen.
2001: dotcom bubble burst. 9/11 attacks.
2008-09: Great Recession. collapse of housing bubble.

There were other causality factors as well, but monetary tightening seems to be a common theme.

For dates and causes, see List of recessions in the United States

grok87
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Re: yield curve inversion

Post by grok87 » Sat Jul 07, 2018 11:33 am

grayfox wrote:
Sat Jul 07, 2018 10:13 am
Looking at this chart, it seems like almost every recession since 1954 was proceeded by the Fed Funds Rate increasing.

Image
FRED: Effective Federal Funds Rate

Recession of:

1957-58: Tight monetary policy
1960-61: Another monetary recession
1969-70: Fiscal Tightening and monetary tightening
1973-75: OPEC oil crisis
1980: Volcker raised interest rates to fight inflation
1981-82: 1979 Iran Revolution caused energy crisis. Tight monetary policy to control inflation.
1990-91: oil price shock. This looks like an exception, rates had fallen.
2001: dotcom bubble burst. 9/11 attacks.
2008-09: Great Recession. collapse of housing bubble.

There were other causality factors as well, but monetary tightening seems to be a common theme.

For dates and causes, see List of recessions in the United States
sure. but i have heard a quote to the effect the yield curve/fed tightening has predicted 8 of the last 4 recessions
:)
nice chart.
but look at nov 1966
sep 1984
may 1995
(easier to do at your link)
remember the bad recession of the mid 90s (didn't happen)
and also the mid 80s (didn't happen)

cheers,
grok
Keep calm and Boglehead on. KCBO.

Beensabu
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Re: yield curve inversion

Post by Beensabu » Sat Jul 07, 2018 2:59 pm

grok87 wrote:
Sat Jul 07, 2018 11:33 am
grayfox wrote:
Sat Jul 07, 2018 10:13 am
Looking at this chart, it seems like almost every recession since 1954 was proceeded by the Fed Funds Rate increasing.

Image
FRED: Effective Federal Funds Rate

Recession of:

1957-58: Tight monetary policy
1960-61: Another monetary recession
1969-70: Fiscal Tightening and monetary tightening
1973-75: OPEC oil crisis
1980: Volcker raised interest rates to fight inflation
1981-82: 1979 Iran Revolution caused energy crisis. Tight monetary policy to control inflation.
1990-91: oil price shock. This looks like an exception, rates had fallen.
2001: dotcom bubble burst. 9/11 attacks.
2008-09: Great Recession. collapse of housing bubble.

There were other causality factors as well, but monetary tightening seems to be a common theme.

For dates and causes, see List of recessions in the United States
sure. but i have heard a quote to the effect the yield curve/fed tightening has predicted 8 of the last 4 recessions
:)
nice chart.
but look at nov 1966
sep 1984
may 1995
(easier to do at your link)
remember the bad recession of the mid 90s (didn't happen)
and also the mid 80s (didn't happen)

cheers,
grok
The yield curve did not invert in the mid 80s or mid 90s. However, it did in 1966.

Image
FRED: Effective Federal Funds Rate, 10-Year Treasury Constant Maturity Rate-1-Year Treasury Constant Maturity Rate

EDIT: Although there was no recession, apparently something did happen in 1966: A Historical Analysis of the Credit Crunch of 1966
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next."

grok87
Posts: 8381
Joined: Tue Feb 27, 2007 9:00 pm

Re: yield curve inversion

Post by grok87 » Sat Jul 07, 2018 3:45 pm

Beensabu wrote:
Sat Jul 07, 2018 2:59 pm
grok87 wrote:
Sat Jul 07, 2018 11:33 am
grayfox wrote:
Sat Jul 07, 2018 10:13 am
Looking at this chart, it seems like almost every recession since 1954 was proceeded by the Fed Funds Rate increasing.

Image
FRED: Effective Federal Funds Rate

Recession of:

1957-58: Tight monetary policy
1960-61: Another monetary recession
1969-70: Fiscal Tightening and monetary tightening
1973-75: OPEC oil crisis
1980: Volcker raised interest rates to fight inflation
1981-82: 1979 Iran Revolution caused energy crisis. Tight monetary policy to control inflation.
1990-91: oil price shock. This looks like an exception, rates had fallen.
2001: dotcom bubble burst. 9/11 attacks.
2008-09: Great Recession. collapse of housing bubble.

There were other causality factors as well, but monetary tightening seems to be a common theme.

For dates and causes, see List of recessions in the United States
sure. but i have heard a quote to the effect the yield curve/fed tightening has predicted 8 of the last 4 recessions
:)
nice chart.
but look at nov 1966
sep 1984
may 1995
(easier to do at your link)
remember the bad recession of the mid 90s (didn't happen)
and also the mid 80s (didn't happen)

cheers,
grok
The yield curve did not invert in the mid 80s or mid 90s. However, it did in 1966.

Image
FRED: Effective Federal Funds Rate, 10-Year Treasury Constant Maturity Rate-1-Year Treasury Constant Maturity Rate

EDIT: Although there was no recession, apparently something did happen in 1966: A Historical Analysis of the Credit Crunch of 1966
thanks for the link. looks like an interesting read
Keep calm and Boglehead on. KCBO.

stlutz
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Re: yield curve inversion

Post by stlutz » Wed Jul 11, 2018 7:37 pm

Going back to this question I raised last week:
A question partially raised by another thread that's going on now as well. Is there any suggestion that inverting the curve *causes* a recession to occur? Or would the claim simply be that long-term rates tend to be a little "smarter" in economic forecasting than short term rates (and by extension, the Federal Reserve)?
I actually did hear someone on CNBC (!) argue exactly this--that yield curve inversion causes a recession. The argument is that yield curve flattening leads to a growth in leverage. When you borrow short and lend long, if the margin from doing so is small, the way to keep profits up is to lever it up--to make the same profits as I could with a steep yield curve I have to make many more loans.

When the curve inverts, then the flow of credit completely shuts off. If it costs more to borrow than you can make from lending, who will lend? If there is no credit then economic activity slows and you have a recession.

In short, a flattening curve creates something of a bubble and then inversion pops the bubble.

That's probably a gross oversimplification of the argument, but it was interesting to me at least...

grok87
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Joined: Tue Feb 27, 2007 9:00 pm

Re: yield curve inversion

Post by grok87 » Wed Jul 11, 2018 8:41 pm

stlutz wrote:
Wed Jul 11, 2018 7:37 pm
Going back to this question I raised last week:
A question partially raised by another thread that's going on now as well. Is there any suggestion that inverting the curve *causes* a recession to occur? Or would the claim simply be that long-term rates tend to be a little "smarter" in economic forecasting than short term rates (and by extension, the Federal Reserve)?
I actually did hear someone on CNBC (!) argue exactly this--that yield curve inversion causes a recession. The argument is that yield curve flattening leads to a growth in leverage. When you borrow short and lend long, if the margin from doing so is small, the way to keep profits up is to lever it up--to make the same profits as I could with a steep yield curve I have to make many more loans.

When the curve inverts, then the flow of credit completely shuts off. If it costs more to borrow than you can make from lending, who will lend? If there is no credit then economic activity slows and you have a recession.

In short, a flattening curve creates something of a bubble and then inversion pops the bubble.

That's probably a gross oversimplification of the argument, but it was interesting to me at least...
thanks, very interesting
Keep calm and Boglehead on. KCBO.

averagedude
Posts: 178
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Re: yield curve inversion

Post by averagedude » Wed Jul 11, 2018 9:17 pm

Inverted yield curve and the CAPE at 30? THIS TIME IS DIFFERENT. Ever heard that before? Im just talking smack, but any time there is a big bear market, everyone says that it was obvious. I believe in staying the course, but it is prudent as ever to make sure that your risk level matches your asset allocation.

grok87
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Re: yield curve inversion

Post by grok87 » Thu Jul 12, 2018 9:28 am

averagedude wrote:
Wed Jul 11, 2018 9:17 pm
Inverted yield curve and the CAPE at 30? THIS TIME IS DIFFERENT. Ever heard that before? Im just talking smack, but any time there is a big bear market, everyone says that it was obvious. I believe in staying the course, but it is prudent as ever to make sure that your risk level matches your asset allocation.
I think that is exactly right. There is a tendency in times like these to up your stock allocation or fail to rebalance. I’m seeing a lot of- why not 100% stock threads or retirees going wiTh like 75/25 stock bond mixes- much too aggressive for most people imho unless you have substantial social securiTy and pension.

Now is the time that leverage is building up in the system and the seeds of a future shock are being down.

Stay the course, keep to your target asset allocation.

Keep cAlm and boglehead on!
KCBO

Cheers,
Grok
Keep calm and Boglehead on. KCBO.

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Kevin M
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Contact:

Re: yield curve inversion

Post by Kevin M » Thu Jul 12, 2018 2:30 pm

stlutz wrote:
Wed Jul 11, 2018 7:37 pm
Going back to this question I raised last week:
A question partially raised by another thread that's going on now as well. Is there any suggestion that inverting the curve *causes* a recession to occur? Or would the claim simply be that long-term rates tend to be a little "smarter" in economic forecasting than short term rates (and by extension, the Federal Reserve)?
Extract from the June FOMC meeting:
Meeting participants also discussed the term structure of interest rates and what a flattening of the yield curve might signal about economic activity going forward. Participants pointed to a number of factors, other than the gradual rise of the federal funds rate, that could contribute to a reduction in the spread between long-term and short-term Treasury yields, including a reduction in investors' estimates of the longer-run neutral real interest rate; lower longer-term inflation expectations; or a lower level of term premiums in recent years relative to historical experience reflecting, in part, central bank asset purchases. Some participants noted that such factors might temper the reliability of the slope of the yield curve as an indicator of future economic activity; however, several others expressed doubt about whether such factors were distorting the information content of the yield curve. A number of participants thought it would be important to continue to monitor the slope of the yield curve, given the historical regularity that an inverted yield curve has indicated an increased risk of recession in the United States. Participants also discussed a staff presentation of an indicator of the likelihood of recession based on the spread between the current level of the federal funds rate and the expected federal funds rate several quarters ahead derived from futures market prices. The staff noted that this measure may be less affected by many of the factors that have contributed to the flattening of the yield curve, such as depressed term premiums at longer horizons. Several participants cautioned that yield curve movements should be interpreted within the broader context of financial conditions and the outlook, and would be only one among many considerations in forming an assessment of appropriate policy.
(Underline mine)

Not sure the underlined part implies a belief in causation, but some of the FOMC certainly think it's something to watch.

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

grok87
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Re: yield curve inversion

Post by grok87 » Thu Jul 12, 2018 4:48 pm

Thanks. Very interesting. The fed’s focus on the increased RISK of recession feels right to me. Ie there is no certainty. They don’t know MUCH more than the rest of us about what is going on...

Just to repost some of the numbers I posted up thread, According to the ny fed model if the 10 yr - 3 month spread is :

100 bps then the probability of recession 1 year from now is 12.5%

0 bps then 30%

-100 bps then 54%

As of today the spread is 86bps so probability around 15%.

KCBO!

Cheers
Grok
Keep calm and Boglehead on. KCBO.

feh
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Re: yield curve inversion

Post by feh » Fri Jul 13, 2018 11:24 am


feh
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Re: yield curve inversion

Post by feh » Sat Jul 14, 2018 8:26 am

There is one action I will probably take if the 2/10 year spread continues to narrow - sell my bank loan fund. I purchased it a few years ago to spice up my fixed income dividends. Such funds tend to dip during recessions.

inbox788
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Re: yield curve inversion

Post by inbox788 » Sat Jul 14, 2018 7:51 pm

corn18 wrote:
Sat Jul 07, 2018 7:48 am
Let's say we knew for certain that a recession was going to start in 2021 and last 18 months. What would you do differently than you are now? Sell stocks? Sell Bonds? Go all cash? Doesn't seem to be a good countermeasure to a recession.
IF, and that's a big IF you could time it well, you could go into "defensive stocks" like consumer staples and other recession proof or recession resistant holdings. Additionally, you'd have to figure out if you should do it now or in the end of 2020, or some optimal time inbetween. And you'd have to figure out how the 18 months of recession impact your getting out of the position.

https://www.investopedia.com/articles/i ... stries.asp

You could also short cars, durable goods, and travel.
https://www.bls.gov/opub/btn/volume-3/h ... covery.htm

You might also want to get out of banks and other financial companies or take the added step of shorting them, too.
http://www.crainsnewyork.com/article/20 ... e-on-banks
https://www.thestreet.com/investing/jp- ... t-14650261

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Rowan Oak
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Re: yield curve inversion

Post by Rowan Oak » Thu Jul 19, 2018 1:47 pm

Lately, however, it seems that market participants are contemplating the opposite possibility--slowing economic growth and perhaps even a recession. The yield curve is currently flat, meaning that long-term bonds are yielding no more than shorter-term ones. The fact that investors aren't demanding any extra recompense for owning long-term bonds indicates they believe inflation--and in turn interest rates--will remain low. Historically, an inverted yield curve (a step beyond today's flat yield curve)--when investors are demanding a higher yield from short-term bonds than they are from long-term--has been a harbinger of economic weakness to come.

Of course, no one knows which of those two scenarios will play out. It's also entirely possible that neither will, exactly; there's always the risk of some type of heretofore-uncontemplated market shock. That underscores the case for building an all-weather portfolio--one that can withstand rising interest rates and inflation, as well as slack economic growth and even recession. The downside of taking a diversified tack is that it will be a rare market environment when your portfolio is firing on all cylinders; you'll inevitably own some laggard holdings at any given point in time. But nor will you run the risk that all of your holdings will fall simultaneously...
Is Your Retirement Portfolio All-Weather?
Christine Benz
09 Jul 2018

https://www.morningstar.com/articles/87 ... ather.html
“If you can get good at destroying your own wrong ideas, that is a great gift.” – Charlie Munger

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