Yield Curves During Deflation

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packer16
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Yield Curves During Deflation

Post by packer16 » Mon May 18, 2020 1:55 pm

I was looking at the times the US/UK has had deflation & in both periods of time the yield curve was inverted most of the time. However, when I looked at the data the comparison was between longer term government bonds and shorter term call money or high grade commercial lenders. Has anyone looked at this as this is where we may be headed? Thanks.

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arcticpineapplecorp.
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Re: Yield Curves During Deflation

Post by arcticpineapplecorp. » Mon May 18, 2020 2:44 pm

is the yield curve predictive of a recession (or coming out of one, which I assume you're more interested in)?

are we experiencing deflation? I'm not experiencing that at the grocery store.
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Re: Yield Curves During Deflation

Post by SimpleGift » Mon May 18, 2020 3:07 pm

packer16 wrote:
Mon May 18, 2020 1:55 pm
Has anyone looked at this, as this is where we may be headed?
There's been long periods in U.S. history when future deflation (rather than inflation) was the predominant expectation by investors — and thus the Treasury yield curve was consistently inverted (chart below). In fact, up until about 1930, a negatively-sloped yield curve was the norm. It's only been since about 1980 that investors have had consistent expectations for inflation in the future, and thus a mostly positively-sloped yield curve.
With an explicit 2% inflation target by the modern Fed, it's hard to imagine the U.S. going to back to a time when future deflation was the dominant expectation, rather than inflation — except for temporary periods around recessions.

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Re: Yield Curves During Deflation

Post by packer16 » Mon May 18, 2020 3:47 pm

Thanks. That graph is what I saw also. If we assume the market is telling us something versus being manipulated, then would not it not be signalling deflation so low nominal long-term rates make sense. It appears COVID has shaken the pillars of two remaining area of inflation (urban real estate & education). The only other pillar is healthcare then most every product & service will be in deflation mode. In this world, inflation will be the exception and deflation the norm. The investment implications would be interesting as the case for LTT would still be there driven by technology advances reducing the cost of everything. I imagine stocks in commodity industries would suffer but those with moats would be more resilient.

If you look at what tipped deflation to inflation in early 1900s and 1930s, it was three things, increased population, war destroying the supply and rising living standards with a fixed supply. Population growth has slowed, war has not destroyed supply, technology has created more supply which has allowed us to have a better standard of living without costing more.

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Re: Yield Curves During Deflation

Post by SimpleGift » Mon May 18, 2020 6:09 pm

packer16 wrote:
Mon May 18, 2020 3:47 pm
If you look at what tipped deflation to inflation in early 1900s and 1930s, it was three things, increased population, war destroying the supply and rising living standards with a fixed supply. Population growth has slowed, war has not destroyed supply, technology has created more supply which has allowed us to have a better standard of living without costing more.
The three current factors you mention are indeed deflationary (or at least disinflationary) — plus the world is now in the midst of a serious deflationary shock of uncertain dimensions and duration.

However, persistent deflation is one of the Fed's absolute worst fears today, I believe, and they will move heaven and earth to prevent it from taking root in the U.S. economy. Thus, their rapid cut in short-term interest rates to zero, and their several trillion dollars in rescue/stimulus funds. They've seen what resulted from Japan's rather tepid response to deflationary pressures in the 1990s, and what can happen when expectations for deflation become entrenched among investors, consumers and businesses.

All the same, while positive (but low) inflation is currently the long-term expectation of the world's major bond markets, investors would be well served I think to hold onto their allocations to high-quality bonds, notes and cash, as insurance against the small possibility of deflation down the road.

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Re: Yield Curves During Deflation

Post by packer16 » Tue May 19, 2020 10:37 am

SimpleGift wrote:
Mon May 18, 2020 6:09 pm
packer16 wrote:
Mon May 18, 2020 3:47 pm
If you look at what tipped deflation to inflation in early 1900s and 1930s, it was three things, increased population, war destroying the supply and rising living standards with a fixed supply. Population growth has slowed, war has not destroyed supply, technology has created more supply which has allowed us to have a better standard of living without costing more.
The three current factors you mention are indeed deflationary (or at least disinflationary) — plus the world is now in the midst of a serious deflationary shock of uncertain dimensions and duration.

However, persistent deflation is one of the Fed's absolute worst fears today, I believe, and they will move heaven and earth to prevent it from taking root in the U.S. economy. Thus, their rapid cut in short-term interest rates to zero, and their several trillion dollars in rescue/stimulus funds. They've seen what resulted from Japan's rather tepid response to deflationary pressures in the 1990s, and what can happen when expectations for deflation become entrenched among investors, consumers and businesses.

All the same, while positive (but low) inflation is currently the long-term expectation of the world's major bond markets, investors would be well served I think to hold onto their allocations to high-quality bonds, notes and cash, as insurance against the small possibility of deflation down the road.
Very good points. We will see if the Fed can fight the market when it wants to be deflationary. Thusfar, they have been able to prevent liquidity lock-up, which is good but have not been able to stoke any type of inflation. They have increased money supply but declining velocity has offset most of the increase. Supporting asset value (bonds & stocks) can stem the decline in velocity but if the trend is down due to the market, how do you ultimately stop it without a reduction in goods & service supply?

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Re: Yield Curves During Deflation

Post by Phineas J. Whoopee » Wed May 20, 2020 8:42 pm

arcticpineapplecorp. wrote:
Mon May 18, 2020 2:44 pm
is the yield curve predictive of a recession (or coming out of one, which I assume you're more interested in)?

are we experiencing deflation? I'm not experiencing that at the grocery store.
And, as we've made you well aware, food is but one aspect of CPI-U.

PJW

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Re: Yield Curves During Deflation

Post by Dale_G » Thu May 21, 2020 1:02 am

I am in the inflation camp. [OT comment removed by admin LadyGeek] Productivity for essential goods and services will go down significantly.

Once the "going out of business" sales are over, look for increased prices in almost everything you buy. I won't even mention taxes which I include in my personal inflation index. I don't expected any changes in federal rates or brackets for 2021, but how about a "surcharge" - maybe 10 or 20%.

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Re: Yield Curves During Deflation

Post by LadyGeek » Fri May 22, 2020 6:49 pm

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Re: Yield Curves During Deflation

Post by stan1 » Fri May 22, 2020 7:08 pm

Right now is why we diversify.
There's no way to predict anything.

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Re: Yield Curves During Deflation

Post by packer16 » Fri May 22, 2020 7:50 pm

Dale_G wrote:
Thu May 21, 2020 1:02 am
I am in the inflation camp. [OT comment removed by admin LadyGeek] Productivity for essential goods and services will go down significantly.

Once the "going out of business" sales are over, look for increased prices in almost everything you buy. I won't even mention taxes which I include in my personal inflation index. I don't expected any changes in federal rates or brackets for 2021, but how about a "surcharge" - maybe 10 or 20%.

Dale
Do you have any evidence that this will happen either currently or in history?

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Re: Yield Curves During Deflation

Post by Dale_G » Sun May 24, 2020 1:46 am

packer16 wrote:
Fri May 22, 2020 7:50 pm
Dale_G wrote:
Thu May 21, 2020 1:02 am
I am in the inflation camp. [OT comment removed by admin LadyGeek] Productivity for essential goods and services will go down significantly.

Once the "going out of business" sales are over, look for increased prices in almost everything you buy. I won't even mention taxes which I include in my personal inflation index. I don't expected any changes in federal rates or brackets for 2021, but how about a "surcharge" - maybe 10 or 20%.

Dale
Do you have any evidence that this will happen either currently or in history?

Packer
If you are asking about surtaxes, I have no evidence that it will happen, but it happened in the past, is happening now and can easily happen in the future.

Surtaxes are applied above and beyond the "ordinary" tax rate - normally based on income.

We presently have:

1. An additional 0.9% tax on Medicare is based on income beyond a certain income level
2. Capital gains taxes are increased from 0% to 15% to 20% above a certain income levels
3. A surcharge of 3.8% is levied on net investment income above a certain level.
4. IRMAA is a surtax

On a historical basis:

In 1968, President Lyndon B. Johnson enacted a 10% surtax on individual and corporate income to help pay for the cost of fighting the Vietnam War. The surtax was collected on income after the ordinary federal income tax was assessed.

The cool thing about a surtax is that it only effects the taxes of people already paying taxes. Most people don't care. And it is easy to implement without changing rates or brackets. Expect to see it.

Dale
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