Best Posts in Thread: Inverted Yield

  1. FireFoley

    FireFoley Senior Member
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    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
    • FireFoley

      FireFoley Senior Member
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      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.
       
      • NVGator

        NVGator Member
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        Nobody knows what you just said or what your graph suggests. Novices here.
         
        • bradgator2

          bradgator2 Internet Bully
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          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.
           

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