Inverted Yield

Discussion in 'Business, Investing & Finance' started by bradgator2, Aug 14, 2019.

  1. bradgator2

    bradgator2 5k - 19 minutes, 39 seconds @ 41 years young
    Lifetime Member

    Joined:
    Jun 12, 2014
    Messages:
    5,743
    Oxbucks:
    $3,366
    Ratings:
    +9,579 / -65
    I have read 10 articles on it and still don’t understand what it is. What’s the panic?

    Someone explain it to a physicist.
     
  2. Concrete Helmet

    Concrete Helmet Hook, Line, and Sinker
    Lifetime Member

    Joined:
    Jul 29, 2014
    Messages:
    10,915
    Oxbucks:
    $4,508
    Ratings:
    +8,802 / -451
    That's like when you go down on your girl upside down.....
     
  3. FireFoley

    FireFoley Senior Member
    Lifetime Member

    Joined:
    Nov 19, 2014
    Messages:
    2,359
    Oxbucks:
    $1,517
    Ratings:
    +2,791 / -167
    I will try to give an elementary explanation and an elementary example, and will not go into details b/c of the current rate levels etc.

    An inverted yield curve is based on the U.S Treasury rates. U.S Treasury rates go from anywhere from 1 day (the shortest) to 30 yr. bonds (the longest). Generally speaking when you loan your money to the U.S. Gov't (which is what you do if you buy a treasury) the longer the term usually gives you a higher rate, which makes sense b/c the longer you tie up your money the better rate you should get. This is basically how old school banks make money. You having a savings account and they pay you an overnight rate. They then take that money and lend it long term, say for a morgtage. But if they have to pay more to you than they can loan it out for, they can't make money. This won;t happen in reality, but it is one of the things that was happening in 2003-2008 and was part of the credit crisis that caused the modern day depression. So when the shortest rate is the lowest and progressively gets higher the longer in time, this is called a normal yield curve. An inverted yield curve is when any of the shorter duration rates is higher than any longer term rate. For example the 3 month T-Bill has had a much higher yield than the 2, 5, and 10 year T-notes for quite a while now, thus the yield curve has been inverted for a long time now. However today for a brief moment, the 10 year T-Note had a rate lower than the 2 year T-note, thus an inversion in the 2-10 spread. The reason it is all over the papers is that this particular inversion is closely followed by many and often seen as a good indicator of a recession to come. I personally think that the 3 month to 10 year is a better tell, but that is another topic. So in short an inverted yield curve is when a shorter term maturity instrument carries a higher interest rate than a longer term maturity instrument in that same family.

    Oh and the simple answer as to why the panic is that it has been that recession indicator 6-24 months down the road.
     
    #3 FireFoley, Aug 14, 2019
    Last edited: Aug 14, 2019
    • Gator By Marriage

      Gator By Marriage A convert to Gatorism
      Lifetime Member

      Joined:
      Dec 31, 2018
      Messages:
      2,478
      Oxbucks:
      $3,657
      Ratings:
      +3,763 / -41
      Outstanding explanation in layman’s terms. I too have read several articles and your explanation is the best one I’ve seen yet. What’s your take on it as an indicator? The stories I read claimed it had never been wrong as an indicator, but there’s a first time for everything.....
       
      • no1g8r

        no1g8r Well-Known Member
        Lifetime Member

        Joined:
        Oct 23, 2017
        Messages:
        638
        Oxbucks:
        $1,242
        Ratings:
        +1,274 / -28
        I’ve heard an inverted yield curve is a predictor of a recession 50% of the time. So it’s still a coin toss.
         
      • FireFoley

        FireFoley Senior Member
        Lifetime Member

        Joined:
        Nov 19, 2014
        Messages:
        2,359
        Oxbucks:
        $1,517
        Ratings:
        +2,791 / -167
        Thanx for the kind words. The predictive power of this inversion is almost perfect, however the curve needs to stay inverted for a period of time longer than a quick blip, meaning a few months or more. Secondly, every time this happens the talking heads always say it is different this time, so it does not matter, but it always turned out to be a good indicator. Yes this yield curve has been inverted for quite a while, but not in the 2 year versus the 10 year. There is one HUGE difference this time as compared to the previous times. Never have interest rates been anywhere near this low when a curve inversion happened.10+ years ago I remember having 1 year CD's at around 6% and the 10 year was like 5% or so. So this is different, and I am not sure how much the inversion matters with rates this low. But my opinion is that since a few of the major economies of the world have negative interest rates (some out as far as 30 years), and everyone else has low rates, tells me that the world economy is in a deep slowdown. Unless something turns around soon in the world, I can't see the U.S. carrying the torch for everyone.
         
        • Gator By Marriage

          Gator By Marriage A convert to Gatorism
          Lifetime Member

          Joined:
          Dec 31, 2018
          Messages:
          2,478
          Oxbucks:
          $3,657
          Ratings:
          +3,763 / -41
          That makes a lot of sense, particularly the part about the low interest rates. Thanks
           
        • bradgator2

          bradgator2 5k - 19 minutes, 39 seconds @ 41 years young
          Lifetime Member

          Joined:
          Jun 12, 2014
          Messages:
          5,743
          Oxbucks:
          $3,366
          Ratings:
          +9,579 / -65
          Awesome, this is great.

          2 follow up questions:
          1) So why is the 3 month vs 10 year a better indicator than the 2 yr vs 10 year?

          2) And more importantly... Are there opportunities to take advantage of or things that make sense from a slide your money around standpoint? I am roughly 20 years from retirement, so I am in the "let-it-ride" mode anyway. The thought of another "2008" doesnt even move the needle for me from a risk standpoint. But that doesnt mean I dont want to be smart about it.
           
          • FireFoley

            FireFoley Senior Member
            Lifetime Member

            Joined:
            Nov 19, 2014
            Messages:
            2,359
            Oxbucks:
            $1,517
            Ratings:
            +2,791 / -167
            1). In my opinion the greater the distance between the maturities of the inversion says something is clearly askew, sans some exogenous event. I say this b/c I have clear experience in the credit crisis depression from 10+ years ago, and called the housing crash, etc. However I did not have any idea what was under the hood regarding all those hidden CMO's CDO's, etc. etc that AIG had underwritten and insured, setting off the implosion. But what was evident was that banks and other lenders needed as much money as they could get their hands on b/c they were loaning it out so fast for mortgages b/c people were buying multiple houses at a time. And as you know a bank, etc. can only lend out an amount up to a certain percentage of its reserves and all of them had reached that limit, thus the high CD and saving rates they were offering. Today banks are required to keep a higher % in their reserves. But I know for a fact that is not the case today and that is not why the curve is inverted. Banks have plenty of money to loan out, just look at how much they have on deposit at the Federal reserve and loan demand is almost zero. Firstly, 10 yr. rates are 1.5% and 30yr rates are below 2%, clearly saying their is no inflation and none on the horizon and as well as tepid to no long term growth. My sense is that b/c the Federal Reserve Board raised the Fed Funds (overnite) rate to about 2.5% from ZERO the past few years in hopes of some semblance of normal, is why there is an inversion. As these short term rates were rising, the longer term stuff has gone nowhere (to the FED's dismay) predicting no growth and no inflation. Therefore I expect the FED to begin to cut the Fed Funds rate aggressively beginning at its next meeting in hopes for curing this inversion. In my opinion it will not matter as it would be better if the inversion was cured thru long rates going up meaning world economies were good and some inflation was on the way.

            2) I envy you in that you have a lot of time before you retire or need the money. If I was much younger I would be hoping the stock market went lower and lower, allowing to get the companies you like as prices decline and you have the time. I would say since getting returns in safe, fixed income investments is very difficult, unless you want junk bonds (which are not safe BTW), I would say buy stocks in companies you know or like as they decline in price. At my age, I want and need monthly fixed income, so for years now I have taken to buying stocks that I think have good paying and sustainable dividends. So even for the older folk, what we may lose in principal on paper as the market falls can be used as a way to buy stocks at lower prices, thus offering a higher dividend % yield. And b/c of your time horizon you may even have the opportunity to buy some of these high flying tech companies that seem to be volatile and that I have no idea what they do. But I always say when you have these things that you have to watch them carefully and remember no one ever went broke taking a profit.
             
            • Gatordiddy

              Gatordiddy Well-Known Member
              Lifetime Member

              Joined:
              Jul 23, 2014
              Messages:
              4,414
              Oxbucks:
              $3,230
              Ratings:
              +5,453 / -22
              • FireFoley

                FireFoley Senior Member
                Lifetime Member

                Joined:
                Nov 19, 2014
                Messages:
                2,359
                Oxbucks:
                $1,517
                Ratings:
                +2,791 / -167
                Thanx for posting this. I like Chris Whalen and he is very knowledgeable about the banking sector and Fed policy in particular. However I wish he would not have quoted Brian Wesbury, the perma bull of all time. I remember seeing Wesbury on TV in 2006 or 2007 when it was clear we were heading south and he was saying the FED needed to raise rates b/c the economy was booming and this was when the Fed Funds rate was at 5% or so. Well we all know where we ended up: The bailout of all bailouts.
                 
              • bradgator2

                bradgator2 5k - 19 minutes, 39 seconds @ 41 years young
                Lifetime Member

                Joined:
                Jun 12, 2014
                Messages:
                5,743
                Oxbucks:
                $3,366
                Ratings:
                +9,579 / -65
                It was early 2001 and I was working at my 1st real job post college. A very, very senior engineer (within a year or 2 of retirement) walks up to me and says his daughter just started working at a new tech startup. IPO will be offered in the next several months and it should be right at $1.00. He was almost begging me to buy $1000 worth. I told him the idea sounded dumb and there was noway Blockbuster could go be beat. Of course, I am talking about Netflix. I like to dream about that one. I definitely hold for the long term... but even I would have cashed out a long time ago :lol:

                Thanks for the input
                 
              • Gator By Marriage

                Gator By Marriage A convert to Gatorism
                Lifetime Member

                Joined:
                Dec 31, 2018
                Messages:
                2,478
                Oxbucks:
                $3,657
                Ratings:
                +3,763 / -41
                Great point about the overnight rate.
                 
              • Politigator

                Politigator L-boy's Cousin

                Joined:
                Oct 5, 2018
                Messages:
                2,477
                Oxbucks:
                $779
                Ratings:
                +786 / -1,302
                From a couple of things I read, the later bond buying QEs resulted in a bloated FED balance sheet and a big increase in bank reserves. That is obvious. But the narrative was that banks just weren't lending it out. And that isn't exactly right. As explained, those fed bank reserved just basically sit there. By definition it can't be loaned. It can be proven by going through the series of debits and credits of the fed buying bonds from banks, which I can't possibly replicate. This particular QE isn't like "printing money". It doesn't inject massive cash inflows into the system. But the goal is to drive long term rates down by buying the bonds.

                However a side effect of ultra low interest rate is there is less motivation by govt to reign in deficit spending.


                Speaking about the crisis, have you seen the Big Short? It is actually both entertaining and insightful.
                 
              • 78

                78 Dazed and Confused
                Lifetime Member

                Joined:
                Jun 9, 2014
                Messages:
                14,479
                Oxbucks:
                $11,052
                Ratings:
                +17,051 / -691
                Good discussion. What many don't know is the ratio of debt to equity investment in the global economy. Stocks are a blip.

                Follow the bond market for trends, and in addition to the 10/2 spread keep an eye on the high yield spread.

                Interestingly, it doesn't paint the same picture at the moment.[​IMG]
                 
              • NVGator

                NVGator Member
                Lifetime Member

                Joined:
                Jun 11, 2014
                Messages:
                8,941
                Oxbucks:
                $4,350
                Ratings:
                +8,016 / -332
                Nobody knows what you just said or what your graph suggests. Novices here.
                 
                • Politigator

                  Politigator L-boy's Cousin

                  Joined:
                  Oct 5, 2018
                  Messages:
                  2,477
                  Oxbucks:
                  $779
                  Ratings:
                  +786 / -1,302
                  The spread is increasing which is what you would expect as economy is weakening- correct? Unless you are comparing it to 2016 when the spread was much bigger.

                  I didn't realize the spread was so large in 2016 - I do recall markets having election jitters.
                   
                • Concrete Helmet

                  Concrete Helmet Hook, Line, and Sinker
                  Lifetime Member

                  Joined:
                  Jul 29, 2014
                  Messages:
                  10,915
                  Oxbucks:
                  $4,508
                  Ratings:
                  +8,802 / -451
                  :rotfl: The rules have been rewritten starting in 2016.....non compliance to the Orange Man will cost.
                   
                • 78

                  78 Dazed and Confused
                  Lifetime Member

                  Joined:
                  Jun 9, 2014
                  Messages:
                  14,479
                  Oxbucks:
                  $11,052
                  Ratings:
                  +17,051 / -691
                  Only marginally increasing. What the graph suggests is there remains a healthy appetite for risk.

                  I'd follow this signal before the 10/2, but that's just me.

                  Here it is widened to include the last two recessions. [​IMG]
                   

                Share This Page

                The Box

                Help

                You don't have the necessary permissions to use the chat.

                • About Us

                  Our community sprung up when the Gatorsports message board was shut down in the summer of 2014. We pride ourselves on offering Gator-biased, yet critical discussion among people of all different backgrounds. We are working every day to make sure our community is the best Gator message board you will find.
                • Like us on Facebook

                • Buy us a Zima!

                  The management works very hard to make sure the community is running the best software, best designs, and all the other bells and whistles. Care to buy us a non-alcoholic Zima? We'd really appreciate it! Just click the "Donate" tab at the top of the page.