The U.S. Yield Curve Has Inverted
bloomberg.com
bloomberg.com
I have money on hand and I want to put it into something safe. The US government is constitutionally bound to pay its debts, and is generally considered to be very safe (if not the safest investment around).
The US government sells bonds with different terms. I can buy 1 year bonds, 3 year bonds, 5 year bonds, 10 year bonds, etc. The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note.
Right now, (annualized) rates [1] are approximately as follows:
1 month - 2.30% 6 month - 2.56% 1 year - 2.72% 3 year - 2.84% 5 year - 2.83% 7 year - 2.90% 10 year - 2.98%
Notice that the 3 year rates are higher than the 5 year rates. Generally speaking, if I'm going to lock up my money for more time, I expect a higher return. However, today, the 3 year notes are getting a higher rate of return than the 5 year notes. Why?
Interest rates generally tend to follow the economy at large. When the economy is doing well, people will invest in stocks and other investments and are less willing to pay for the safety of treasuries, so effective rates go up when people bid less at treasury auctions (additionally, the government will take steps via the Federal Reserve to make rates higher). By the same token, when the economy isn't doing well, people want the safety of treasuries, even if they pay less, so effective rates on treasuries tend to go down.
In rare cases, the yield curve will invert. What this means is that investors think that rates of return on government bonds are going to go down in the future. In order to lock in a better rate now, they're willing to pay more for longer term bonds (in this case, 5 year bonds vs. 3 year bonds) in order to "lock-in" the good rates. The assumption is that they won't be able to get the same good rates if they don't act now.
Note that only the 3 and 5 years have inverted. If people were really panicked, you would probably see a more significant inversion, where for example, the 1 year was higher than the 2 year and the 2 higher than the 3, etc.
[1] these rates are actual rates of return calculated based on the auction price paid
Dalio also talks about Thucydides Trap and Paul Kennedy's book on the decline of great powers. He doesn't say it but he seems fairly confident in China surpassing the US as the dominant global power in the near future. The only issue I have is that he seems to think China's high debt is fine compared to the US based on vague reasoning.
The US and the West in general need to wake the fuck up or we're going to be under China's thumb. We've become complacent and assume our status on top of the global hierarchy is guaranteed. China is playing to win and doesn't care about breaking the rules to win
All the Federal Reserve has to do is buy US treasures on the open market at higher and higher prices. A premium on a bond pushes the yield lower. Yields at 0% means that the US will not be paying interest on its [new] debt. Yields at negative means that investors will be paying the US.
People and entities buying US treasury bonds is why they yield 2-ish percent right now at all, instead of say 5%.
Regarding 0% rates, the Bank of Japan has already done this with Japanese government treasuries, for a very long time
Regarding negative rates, the European Central Bank has already done this with its constituent country's government bonds, for several years. Primarily German bonds.
The US can do this with more efficacy than those economies, whenever it chooses to do so. Right now, the US Central Bank chooses to raise rates and the US Treasury continues to issue more debt at the higher rates for reasons unrelated to its budget, to be honest just because the market can bear it. The Federal Reserve chooses to have less dubious assets on its balance sheet.
Everything is done in a form of moderation, but the US has a lot of tools to deal with its debt.
I'm impressed by how high these rates are. The US 10-year bonds pay 2.9%, according to the top post in this thread. Remarkable. According to Bloomberg, the US pays interest rates like Italy, nearly ten times as high as those of Germany.
https://www.bloomberg.com/quote/GBTPGR10:IND https://www.bloomberg.com/quote/GDBR10:IND https://www.bloomberg.com/quote/USGG10YR:IND
Is there a profound insight I am missing that makes this state more unusual than it seems to me right now?
It might also be an issue that the US is not democratic enough, although there are some EU members (as well as the EU itself) that aren't as democratic as they should be.
The interest rate is chosen by the central bank, not by "the market" [1]. A different issue is who try to influence that decision [2].
The FFR (Federal Funds Rate) is the target interest rate for interbank reserve money. (The effective FFR is the average of the actual rates of those transactions between banks.)
And there's the interest rate for Treasury bonds (T-bills) determined via bond auctions.
Now, usually the Fed uses those bonds as collateral to conduct its open market operations that influence the effective FFR to keep it close to the target FFR, but the Fed does not bid on Treasury bond auctions.
Of course if the central bank intervenes and floods the market with cash (and takes assets as collateral, such as bonds) then banks are likely to turn to the Treasury and buy bonds with cash. And the real constraint is of course inflation. The ECB basically does this to keep interest rates low for Eurozone member countries.
Anyway, the central bank can do whatever it wants, but if there were too much inflation no one would want to operate a bank there, so eventually there would be no primary market for gov bonds. (That said the usual Bloomberg/FT/Reuters cries are laughable about how bad poor banks have it with near zero rates.)
these particular bond yields are not a reflection of "how good a country is with money", this is only a discussion in developing nations and their yields are already 8-20%
so this whole discussion is moot.
(Does the central bank usually set the interest rate? Why do lenders accept that decision?)
Who is buying that debt is really the Central Bank of Japan, so, it's really a political decision.
Yes, the central bank have a target interest rate and operate to keep it inside their chosen parameters.
Lenders accept that decision because they have not other option.
From http://bilbo.economicoutlook.net/blog/?p=40937 :
"That is what the Japanese experience since the early 1990s tells us. And all the stories about special cases; cultural peculiarities, closed markets, etc that the mainstream economists wheel out when another one of their predictions about how Japan is about to sink into the sea as a result of its public debt levels, or that interest rates are about to go through the roof because of the on-going and substantial fiscal deficits; or that inflation is about to accelerate because of the massive monetary injections; and more, are just smokescreens to divert our attention from the poverty of their analytical framework. The Japanese 10-year bond trade is called the ‘widow maker’ because hedge funds who try to short it lose big [..]"
Did the United States "get better with money" somehow in the last years before becoming "bad with money" again?
Edit: to be clear, I do know that there are many factors (including as well inflation expectations, for example). It´s not just a question of default risk due to being bad with money.
I don't have the data, but if Germany's yield followed a similar trend down then up, but remained below the US throughout, then the hypothesis holds.
Japan shows that the narrative of "good country" vs. "bad country" and interest rates beyond the control of the Central Bank have little to do with reality.
For example, if the share outlook for the next years looks unusually good/bad volatile/stable (compared to how it looked a couple of years earlier), then that makes shares more/less attractive to investors, and bond issuers have to adjust the rates they offer.
Yes, the economy started to boom but then the government went and issued massive corporate tax cuts while simultaneously increasing spending by quite a bit, which means increase in deficit.
EXTREMELY
The European Central Bank (ECB) has been buying sovereign and corporate debt, the entire yield curve, with new money with the purpose of making yields negative. This lowers interest rates in the eurozone.
This is its own comedy troupe that has nothing to do with the risk of the countries, especially the anything outside of the Eurozone and ESPECIALLY US monetary policy and the market's expectations of US debt.
This is true when you're talking about trading a bond in the secondary market. But for primary sales (i.e. Treasury auctions for brand-new bonds that didn't exist before), the debtor (Treasury's) effective IR is a function of the sale price.
The ECB has been massively inflating the Euro by buying sovereign debt, with the express policy of pushing yields into negative territory so that people invest in riskier assets. OF COURSE that drops the yields of Italian government debt far below what the actual risk is.
This isn't an expression from the collective conscious about the US' finances. wow. or at least it HADN'T been, until now. How long have you been following the debt markets? Your perspective lacks history of anything beyond 3 years...
Doesn't that lead to inflation?
The only difference between treasuries and reserves is, in fact, the interest rate an the fact that we call one "debt" and the other "money". But they are both US federal gov't liabilities denominated in USD. [2]
The bulk of the impact on inflation already happened... when the treasuries were issued in the first place. They aren't waiting to be exchanged for reserves to suddenly cause inflation. [3]
So, if anything, the Federal Reserve swapping one gov't liability for another paying lower interest could lead to less inflation, not more. [4]
[1] https://fred.stlouisfed.org/series/IOER [2] http://bilbo.economicoutlook.net/blog/?p=31715 [3] http://www.cfeps.org/pubs/wp-pdf/WP37-MoslerForstater.pdf [4] https://www.stlouisfed.org/publications/regional-economist/j...
One way to think of the U.S. national debt is as a measure of the future money supply. There are two ways to retire the debt: pay it off through increased productivity (i.e. GDP growth) or print dollars. Debt doesn't cause inflation directly, but it's a potential time bomb if the debt comes due and you can't pay it through productivity growth (or higher taxes).
This doesn't seem like a particularly big deal, until you realize what it does. Imagine the US pumps a bunch of funny money (I'm using a sardonic term just to clearly distinguish between organic/'real' growth) into our economy. This would naturally cause inflation. But here's where the fun kicks in. Oil is still by far the most in demand resource in the world. And now when countries go to buy oil they need to accumulate USD. But now due to inflation a country that wants to buy the same amount of oil needs to keep an even larger reserve of USD on hand. And that's exactly what happens. The USD becomes worth less and countries are obligated to hoover up more USD to ensure access to oil. As that USD starts getting removed from circulation, the effects of the inflation start to abate. Like magic, we can 'print' (not how many is made, but that's another topic) a practically unlimited amount of funny money with minimal economic consequences.
This also explains much of otherwise inexplicable actions in the Mideast and related places. We don't want their oil, we want them to sell their oil in USD only. This [1] is an article from Time in 2000: "Europe's dream of promoting the euro as a competitor to the U.S. dollar may get a boost from SADDAM HUSSEIN. Iraq says that from now on, it wants payments for its oil in euros, despite the fact that the battered European currency unit, which used to be worth quite a bit more than $1, has dropped to about 82[cents]. Iraq says it will no longer accept dollars for oil because it does not want to deal "in the currency of the enemy."" By 2003 we had destroyed the Iraq government and killed Saddam in a kangaroo court. Similarly with Libya, Gaddafi was aiming to create a gold backed 'Afro-currency' which is what he wanted to start selling his oil in. Two other nations which have moved against the petrodollar are Iran and Venezuela.
On the other side of things, this also explains Saudi Arabia. One of the most backwards and repressive nations in existence today, we're still BFF since they act like a loyal lapdog when it comes to the petrodollar. In exchange we let them do just about anything. The CIA has recently stated that Khashoggi's murder was likely ordered all the way from the top. I can tell you how this story will end. Do you remember in 2015 when Saudi Prince Majed Abdulaziz Al Saud had a rape and assault filled 'party' at a rented mansion in Beverley Hills? The 'party' was only stopped once a neighbor called the police after seeing a bleeding woman screaming for help as she tried to scale the fence of his mansion to get away. He was arrested and that's where most media reporting ended. The epilogue is that he was rapidly granted bail, got on a plane and simply flew back to Saudi Arabia with no consequences whatsoever.
---------
This is already getting long enough, but something very important now a days is that the petrodollar is dying. It's a mixture of a perfect storm of a large number different of factors, but it's definitely a dead system walking. And this has major implications for the future of the US economy. To date we've had 'economy armor' on. In the not so distant future, that armor is coming off and our economy will stand or fall under its own weight. And this is when being massively in debt suddenly does start to matter because if you just try to print your way out of it, you would not be able to rely on the petrodollar to protect the economy anymore.
[1] - https://content.time.com/time/magazine/article/0,9171,998512...
[2] - https://www.cbsnews.com/news/saudi-prince-majed-abdulaziz-al...
While I agree the petrodollar is a big deal, and it does afford us a lot of extra leeway in monetary policy, we can't forget that the US is still an economic powerhouse in many, many different industries. And the power of singularly focused economies like Saudi Arabia is waning.
The shallow reporting is that manufacturing is gone, but the reality is, we have higher manufacturing output than ever. (The fewer jobs needed for higher output is a different story.) We have an enormous lead in software. Intel and Qualcomm are the two biggest semiconductor companies. We have the largest oil and natural gas reserves, much of which is still untapped. A large share of world media entertainment is here. The US pharmaceutical industry accounts for almost half of the world output. World banking and finance is huge. Real estate market is enormous and highly desirable to outside investment. And this is for a country with less than 5% of the world's population.
And that's just some of the big stuff that the US leads the way in. There are so many other industries that the US is still a global player in. What I'm getting at is the the breadth and depth of the U.S. economy is so large that it is hard to comprehend and I don't think the failure of any one industry will be enough to produce significant hardship for the US. Nor does the economy need to rely on the petrodollar for protection in the long term.
There's a great podcast which sparked my interest in following macro developments, touching the future of the US dollar in particular - Macro Voices - The US Dollar End Game [1] (there are 5 parts, link points to the first one). I'd also recommend listening/reading the transcripts for all the pieces with Jeffrey Snider, e.g. [2] and his blog [3].
[1]: https://www.macrovoices.com/336-anatomy-of-the-u-s-dollar-en...
[2]: https://www.macrovoices.com/239-jeffrey-snider-understanding...
US inflation management is done by the Fed, which has got rather good at it. It's one of the few big success stories of 20th century economics is working out how to do inflation control with interest rates reliably.
This explains how the US can print money without inflation, why Saudi Arabia is given a pass on a generation of horrible policies, and of course why the Iraq war was performed.
At 0.55% (the figure has possibly have gone down due to the drop in oil prices between 2016 and 2018) they're a significant holder, but hardly a market maker.
This dilutes the value of an individual dollar. Just like dilution of any asset.
In the context of currencies this is called inflation.
Typically the whole point is for private persons to invest into the real economy, even though it is riskier, because these other new ventures are going to try to put it to productive use, instead of any party just parking the money in a bank account since now it is clear it will lose value just parked.
It’s cutely termed shrinkflation.
How does this work?
Why should/will anybody give money to anybody for free?
You could just put it into a bank account, but what if that bank goes under? You are only insured by the FDIC up to $250k. You could put it into 4,000 different banks (essentially every bank in America) each with an account of $250k. But imagine the overhead of opening and keeping track of those. How many accountants will you need to have on staff full time? And lots of banks charge a monthly fee if you aren't making transactions every month.
So are you going to take it in cash? If so, where will you put it? You'll need storage, security, insurance... what if the insurance company goes bust and can't pay out?
All those options are very expensive. But you have the option to put that money into a US government bond, the safest place in the world, and it won't cost you a dime. Free storage.
In Europe, there were actually cases of negative interest rates. So people were paying a little bit of money to loan to the government because it was still the safest and cheapest way to protect their enormous sums.
This is never going to apply to people with $250,000 deposited with the bank. Lots of banks charge a monthly fee if you aren't making transactions and also don't have any money.
Make a large interest-free loan to the bank, and they won't charge you fees for the privilege of making it.
Many retail brokerages will sell you CDs commission-free and keep track of everything for you. They get a commission from the bank for selling them to you. Schwab has a CD search tool with results that keep going page after page after page. I'm sure if you had a billion dollars they'd be happy to have a broker make the purchases for you.
[1] https://www.reuters.com/article/us-snb-results-banks/swiss-b... [2] https://www.ft.com/content/bcc092fc-7743-11e6-a0c6-39e263316...
Or set up 4,000 different legal entities and deposit it all at one bank.
Over the last while, central bankers have been trying to increase inflation rates by keeping rates low, but the market has not been responding as they expected.
..at least inflation didn't go where they wanted it to. Asset prices went up (inflated). It's half based on magic, macroeconomics.
The problem is that the institution responsible for inflation doesn't control the state budget, just central bank lending and banking rules. ...and I don't think you can say with any kind of certainty that "new macro," corbynomics or any of the other current ideas will work, are safe, or don't come with other side effects.
Personally, I'm not sure there's a constantly true answer.
ATM, businesses don't have ways of absorbing more money. You can Google, FB, msft, Amazon or Apple $100m... it probably wouldn't affect what they choose to to in any way. They already have money piling up. Tesla might use the money. They have factories to build, but Tesla's are a rarity.
In that market, to get stimulus/inflation, governments need to spend it themselves.
In 5 years, it could be different.
The problem, imo, with those types of ideas is that public spending is very hard to put in reverse. Even if the value for money sucks, you tend to get trapped spending it.
Edit: The difference is when China bails out its banks it doesn't loan the money into existence to do it. The U.S government must borrow the money from the fed and the interest rate is paid back by the taxpayers. Yes, the interest paid back to the fed goes back to the government, minus expenses. However, those with very large amounts of money, trillions in aggregate, can piggyback on this system and earn enormous risk free returns where they would otherwise have to carefully invest in non-risk free instruments. These risk free assets are unavailable to chinese investors forcing these large savings into various productive (or non-productive based on their investing skill) investments in the economy. They can't go into T-Bills either because of strict currency controls. In the U.S the risk-free trillions invested are guaranteed by the power of taxation of the rest of the productive economy. This austerity to pay the bondholders and ensuing liquidation is what trashes the rest of the economy on a regular basis in Western economies. This doesn't happen in China because the banks get bailed out with printed money and they keep on lending without putting the government in debt or requiring taxes to be raised or austerity.
That China has not had a Japanese style prolonged credit bust even though it has been predicted by "The Economist" and other supposedly learned publications on a regular basis for the last 30 years is a sublime mystery that defines explanation because there is a stubborn refusal to objectively understand and analyze the Chinese financial system. I'd say it's a new paradigm in human organization that really defies western understanding because our financial system is so enormously politically protected by all that trillions in passive capital that gets risk free returns.
This is what is being referred to as printing, but yes its just an unlimited asset issuance function in the currency class of a program
Which makes sense, but - I've been hearing this for couple of decades, and it doesn't seem to happen. I am not sure I understand why it doesn't happen and why people seem to care about the mountain of US debt much less than I think they should - but this looks like what is happening for a while. I still think this will become an issue sometime in the future, but I have no idea how one can predict how soon it would be.
> he seems fairly confident in China surpassing the US as the dominant global power in the near future
That depends a lot of what you mean by "dominant" and "near future", I guess. If you pick your criteria well enough, you could both claim China is already dominant (I mean, look at where all the stuff is manufactured! And their population numbers! And their GDP growth!) or that they are hopelessly behind (I mean, look at their GDP per capita - it's on part with Iraq! Nobody thinks Iraq is dominant... Or look at the immigration patterns - are a lot of people from other developed countries dream to go to China, or vice versa? How dominant can be the country where their own population rather live somewhere else?) So you could make either claim without too much effort.
The kind of people who say that the US's debt is totally going to be a problem any year now have generally being saying that for years, as well as saying that about Japan's since the early 90's.
But MMT proposes that a monetarily sovereign currency issuer (like the US, UK, Japan, Australia, New Zealand, etc. but not Euro-using countries, or anybody with a gold standard, fixed exchange rates etc.) actually have the ability to service any debt denominated in their own currencies, and analysis to pretty confidently say that it would not be inflationary to just pay them out (i.e by money creation). The inflation risk was at the time when the spending of the bond money happened, so paying them out with new money is asset neutral - the only difference is it just gives the bond-holder a more liquid asset.
Then there are other useful tools like sectoral balances, etc. that help explain the links between one of the things that really matters (private debt) and how it relates to Government spending and trade surplus/deficit. A few of the twelve or so people who accurately described the great recession a few years before it happened used this method at the core (e.g. Keen, Godley).
It flies pretty hard in the face of conventional economic wisdom, but I haven't yet found an economic theory that holds up so strongly to real world observation, i.e. in explaining why Greece has huge debt problems but not Germany (Eurozone, but trade surplus) or the US (monetarily sovereign), and why Venezuela and Zimbwabe have their problems (debt denominated in foreign currencies, supply shocks, etc.) vs. Japan (monetarily sovereign) while they seem to do similar things, etc.
Given that, I'm not really sure that Japan is a good example. The US, as well, is in a weird space. China has been quite keen to buy up US debt. This is propping up the US dollar, which I think is an important strategy for Chinese growth. However, I expect the other shoe to drop at some point. Once the Chinese economy is strong enough that they don't want to be the "cheap manufacturing country for the world" (see Japan and South Korea for other examples of this), I suspect they will drop US debt like a hot potato, favouring strong buying power over strong selling power. If the shift their economy and compete head to head with the US in the "value add" sector, I think that debt may cause significant problems.
But this is complicated stuff and I really don't know what I'm talking about :-) It's fun to speculate, though.
It's also a huge bargaining chip. If China dumped a trillion dollars of US financial instruments at firesale prices over the course of a year, that would cause a lot of mayhem.
I mean they suddenly decide that the asset they bought in trillions as safest investment available around is suddenly worthless - and not only try to hide it, but actually loudly proclaim that all their holding are worthless (I imagine so that it would be easier to sell them at the best price?) I don't see China doing something like that. First, they would need to find a reason why US debt has become worse investment than yesterday - and second, even if they find this reason, they won't ever "drop it like hot potato" - that would be a suicide (in Chinese conditions, probably a literal one for somebody that would cause such loss of billions to the state).
> If China dumped a trillion dollars of US financial instruments at firesale prices over the course of a year, that would cause a lot of mayhem.
Why would they? Other than collective insanity, there'd be no reason for such behavior.
What? How would telling the world that US debt is worthless help them sell their holdings of US debt at higher prices?
Economic warfare.
It’s like buying a car from a friend then turning around and selling it for a dollar.
You hurt yourself more than you hurt the other person.
The classic element of currency crises and hyperinflation is always that you can't print foreign currency: if your trade+investment balance is bad enough, imported items become more and more scarce relative to local ones. This crucially includes oil.
That depends on what the creditors do with the money. If they keep it in a bank account, the effect on prices is minimal. If they go out and buy a lot of goods and services or financial instruments like stocks, of course that will inflate prices.
Of course if the US were to destroy its international network, that would change.
As for "waking up", it appears at the moment the decline is not creating a call for clear thinkers and rational solutions but for charismatic leaders who make Ghost Dance variety promises.
This analysis is missing something because inflation is a good thing for country debt denominated in it's own currency. Inflating away the outstanding debt is one of the ways to deal with outstanding debt.
If you get a hot economy that results in both high tax receipts and higher levels of inflation (not hyperinflation), outstanding debt can be worn down pretty quickly.
https://www.nytimes.com/2018/09/25/business/economy/us-gover...
When you owe a trillion dollars to someone, they have a problem.
The US went to war with Iraq and it cost trillions. If China wanted to undermine the US economy and it only costs a few trillion in bad debt it's a bargain if it achieves that goal.
Buy higher than market prices, such as how the BOJ or Eurozone manages its yield curve
Cut social spending programs such as Medicare/Medicaid/Social Security
Cut defense spending
Increase taxes
Inflation cuts existing debt amounts
Or any combination of these. Realistically, most of these.
This yield curve inversion has long been expected and isn't some kind of harbinger of doom. China meanwhile has its own set of precarious economic issues and isn't guaranteed anything.
Oh. There are rules which countries should be following, even if it's to their advantage not too? ;)
Do you have a source that lets us see his quotes?
I would venture a guess that China's much higher saving rate has something to do with it. Their infrastructure investments are probably wasted at times but it seems much of them do help support further urbanization and economic development.
OTOH, the bond markets don't seem to care about our current debt load. And the full faith and credit of the US Treasury still backs the world economy.
What this theory has failed to do over time is to prevent the amount of outstanding public and private debt from perpetually expanding.
During boom times, people are inclined to borrow (i.e. create money) to take advantage of the economic opportunities. What the theory says is that we can/should then adopt policies to pay back debt (i.e. destroy money) at the same time, which can then be done without causing deflation. So that's fine, when times are good the amount of debt will expand less than it might have, though it still expands some because slight inflation is so much better than any deflation.
Then when times are bad, we lower interest rates and engage in deficit spending to stimulate the economy. Debts expand a lot.
Notice that neither of these involves the level of debt ever going down, but one of them involves it going up a lot. Advance a few decades and the level of public and private debt is out of control and the interest payments are becoming a large problem.
So how do we get out of this? At some point the level of debt has to go down, but that destroys money, which causes deflation, which is an unmitigated catastrophe that hyper-regressively increases the real value of everyone's huge outstanding debts.
What we need is a way to create money to offset the currency destruction of debt-reduction without just recreating the debt somewhere else. But we know how to do that -- the government can print money. Then raise bank loan interest rates so that people have the incentive to pay down their debts, while at the same time using the money you're printing to lower taxes without cutting services so that people have that money to use to pay down their debts with.
But printing money has a bad name. Failing countries do it a lot, and people think it will cause inflation. Which it does, of course, but that's the point -- inflation to offset the deflation of reducing debts.
So they're apparently being stealthy about it, because there's a back door into this. Instead of having Congress print money, you have them pass a budget with a huge deficit. Then the Fed creates money to buy the debt. Different accounting, same result. Debt held by the Fed "doesn't count" because the treasury pays "itself" when the bond matures.
The issue now is that the Fed needs to get the rates calibrated right. They needed to be raised from zero to get people to actually start paying down debts, but too much and borrowers start to destroy money faster than Congress is creating it through deficit spending. And a little bit of higher interest rates goes a long way when the amount of outstanding private debt is as high as it is.
So now the Fed is trying to hit its inflation target in the face of all this, resulting in some uncertainty about what rates are going to be in a few years.
It really feels like the chickens are going to come home to roost on the next downturn due to the massive stimulus preventing the last one from being fully realized while simultaneously putting massive debt onto the US balance sheet.
Armstrongeconomics.com & ask-socrates.com
Everyone wants to grab hold of the horns of the charging Chinese bull.
It's why the inverted yield curve is one of the widely looked at indicators for future economic health.
So the yield curve inversion isn't saying the economy right now isn't doing well. What it is saying is that the market ( or a large percentage of institutional investors ) think the economy won't do well in the future.
As you noted, it's only a slight inversion of only the 3 and 5 year, so it isn't that alarming for the moment.
Just as important as the yield curve is what the FED is going to do with interest rates. If they consistently raise it every quarter for the foreseeable future, then the odds of a recession will increase considerably.
So if we look at the very long term rates, do those signal that we are broadly confident that the US economy will be healthy long term? Or is there no signal there?
Betting that the Fed will have to cut rates because of a recession is a bet against equities and other risk assets.
With regards to > that investors think that rates of return on government bonds are going to go down in the future.
Does it mean that investors think that US government will pay 'less interest' in the future for these 5 year bonds ?
If yes, does that mean that investors think that US government will be willing to pay less to its lendors (the bond holders). Which, would also mean that bond buyers think it is good time now to lock in a higher rate.
(seems like a good thing if one is a US taxpayer, if the gov will pay less to money lenders, unless US people are starving...).
For example, Ukrain's 3 year bond pays 18%
http://www.worldgovernmentbonds.com/bond-historical-data/ukr...
As stated in my original post, the treasury sets an interest rate and a face value on its bonds.
Here's what that means (I'm gonna make up some numbers here to keep it simple): Let's say the US Government says we're gonna issue $100 of debt that's going to be paid back with 5% interest in one year [2]. If you were to buy that debt for $100, you would get $105 back at the end of the year, earning you 5% interest. That would be an amazing return for what's pretty much a risk free investment [3]. However, the trick is that they don't sell that note for $100. They auction it off to the highest bidder. So let's say that someone says I'm willing to pay $102 for that note. In that case, the effective yield for the investor is 105/102 - 1 = 0.029412, or roughly 2.9% instead of the original 5%. If the interest rate were 10% instead of 5%, investors would just bid more for those bonds, so the effective yield would be the same (the current yield that the market is willing to pay is about 2.62% for 52-week zero-coupon government bonds, AKA T-Bills), and the government would still effectively be borrowing at the same rate (though they would issue fewer $100 bonds, because each one sells for more).
So back to your point, the rates are set by auction and don't have much to do with what the government is "willing" to pay to its lenders. What it means is that investors think that the market will be willing to pay more for $100, 5% interest notes in the future and therefore effective yield rates will be lower. There are many reasons why they may believe this (for example, ideas about what the Federal Reserve might do), but one of the main ones is a belief that the economy will slow down and stocks prices will fall, or be very volatile. When the economy is good and stock prices are going up, people want a piece of the action, so you they aren't willing to pay for the security of government bonds. But when the market is volatile or going down, investors want safety and are willing to buy government bonds at lower yields.
[1] One can argue semantics on this. In reality, the Federal Reserve, and arguably foreign governments, distort the market somewhat. But let's ignore that for now.
[2] This is called a zero-coupon bond, because you get all your money back at once. Most bonds are actually coupon bonds where for example, you buy the bond for $100 and get $1/year in interest for 10 years and then get your principal back at the end. However, I think the zero-coupon bonds are easier to describe, so I'm using those for this example.
[3] Risk free because the United States government is constitutionally bound to pay its debts and has lots of instruments at its disposal to make sure that these debt payments happen. Sure, there can be a nuclear apocalypse that would prevent this from happening, but in that case, any other investments (other than weapons and canned goods) are worthless anyway. So it's viewed as fairly risk-free as compared to reasonable alternative investments (it's not free to store canned goods).
Its important to point out that these are not market-based auctions. The Federal Reserve regularly steps in to purchase its own bonds (in effect skewing the price of the auction). The FED currently holds ~4 trillion worth of bonds purchased in prior auctions (its not currently increasing its holdings but it is repurchasing).
https://www.federalreserve.gov/monetarypolicy/bst_recenttren...
Central bank purchasing their own bonds can act to prop up the market, but also to disrupt market forces by keeping a "thumb on the scale". While this was initially done as an attempt to stimulate the markets after the crash of 2007/2008, it was never ceased, putting the whole financial system into real jeopardy when there is another crash and central banks have used up all of their bullets. This is a financial experiment with an uncertain end. The balance sheet of the BOJ as recently passed its annual GDP.
https://www.reuters.com/article/us-japan-economy-boj/bank-of...
The unwinding of this many treasuries has always been a concern about the whole 2008 crisis along with the unintended consequences of ZIRP.
One of many concerns! Given that the solvency of the USA and the entire global economy is predicated on interest rates not rising substantially, things are going to get very interesting (not in a good way) next time we have an economic crisis.
Yes, and where are the promised terrible consequences?
The true is the markets have to dance whatever the Central Bank sings [1].
And hopefully that answers your second question as well.
The rate is annualized, meaning the profit if you held the bond for 1 year.
So a 3 year bond at 2.32% pays a 2.32% annual interest rate. Interest payments are made twice a year. A 5 year bond at 2.32% pays the same rate of return — 2.32% interest per year, but in that case guaranteed to continue paying at the same rate for 5 years instead of 3.
The rate is the annual rate. The term is for how long interest payments are made and how long until the bond “matures” — when the face value is paid back.
If people think rates are going to go down in the future, then they will accept a slightly lower rate if it is locked in for a longer term, which is the idea behind the “inversion”.
Later part of the OP's post was mostly focused on this question :)
What about the fact that US treasury is issuing more bonds to fund extremely large deficits? How does that play into the equation you described?
Wouldn't so many bonds flood the market with bonds available and thus raise the yield rates on 10-year?
As can be seen, based on historical data from 1950-now the yield curve signal beats S&P 500 marginally (+110 basis points annually). However, I would not implement it as is, because this could be noise. Looking at the two tables above, the yield curve + 200MA strategy exhibits a problem commonly seen using these types of moving average strategies--whipsaws--which means buying in at a price and being forced by the strategy to sell at a lower price. In table 1, Buy in at at 65.24 and sell at 62.93 is an example of a whipsaw. [2] is an excellent resource if you are interested in learning more about these types of strategies.
[1] https://seekingalpha.com/article/4183120-superior-investment...
Basically it's a lot of noise. It doesn't mean nothing, but...
My apologies in advance that this may not be the response you were looking forward to on forum question.
But I discovered an older post online on the Hacker News site some time ago for a Remote Junior Programmer/Assistant at Luma. I noticed you were looking to make your first hire and find someone that has some knowledge in technologies such as Python and Linux.
Well, I had completely forgot about viewing it and so I was checking out Hacker News job board today and saw it was for a remote Part/Full-time opening available at the Luma in the NYC area.
Well I'm someone who enjoys coding and learning with Python as far as learning purposes/hobbies go. Plus, I'm someone who has been going the self taught route trying to break into the IT field/Python Development world. I also have interests in some of the things mentioned in the post such as finance/trading and business.
But, more than anything.. I'd looking to further learn and grow in my skills as far as Python development goes. I don't have much experience with Django Web development but feel I can learn and pick up on it as well as with any other technology requirements quickly.
After quickly reading your post on Hacker News I was encouraged and interested to reach out and contact you for more info.
So with that said, here I am..and I wanted to inquire to find out if this opening is available? Or has it been filled? Also would you allow for training of junior developers to get up to speed? I had to ask because but I wasn't sure if you meant junior or for more seasoned developers.
Also, you have a contact number to learn more about this position or information on the things you require in regards to the nature of the job to increase one's chances to be a part of your startup team? Any help in this matter will be greatly appreciated. Thank you
Feel free to contact me at: pydeveloper22@gmail.com
--K
There are no certainties, of course, but the probability is pretty high that in the next 6 to 24 months we'll see negative economic growth and increasing unemployment.
Since when? Please point me to the part of the constitution that says that.
Article VI
It requires a minimum of good faith, which you possibly lack. But it clearly implies that debt exists, and that it can be valid. The fact that valid debt is to be repaid is not clearly spelled out in the constitution, because the founding fathers did not believe there would ever be a time where idiot vandals trashed about requiring every minute detail to be proven from first principle.
> The states and the Confederation Congress both incurred large debts during the Revolutionary War, and how to repay those debts became a major issue of debate following the War. Some States paid off their war debts and others did not. Federal assumption of the states' war debts became a major issue in the deliberations of the Constitutional Convention.
As for the rest of your comments, I used to like it when HackerNews was somewhat civil.
What seems closer to what you want is the first part of Section 4 of the 14th Amendment: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”
(Which still, strictly, doesn't say the debt will be paid, only that it's validity will not be questioned.)
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.
To be fair, there has been some debate into how this is interpreted as far as the constitutionality of debt ceilings if they would cause the government to default on its debt. The US has always paid its debts, so the question hasn't been litigated and decided in court.
In any case, constitution or not, the biggest reason not to default on debts is that doing so makes it far more expensive to borrow in the future.
While somewhat noteworthy, it's not huge (yet). When people talk about yield curve inversion and it being an indicator of recessions, it's much more common to compare the 2-year with the 10-year. Currently that sits at 2.83 (2yr) vs 2.98 (10yr). While the shorter spreads do often invert first, there is no requirement for the longer spreads to follow.
I mean, there's no "requirement", but historically their movements correlate with each other closely with a small amount of offset.
https://www.clevelandfed.org/our-research/indicators-and-dat...
Meaning they take short-term deposits (e.g. current account balances) and make long-term loans (e.g. mortgages). They normally make a profit, because they borrow short paying low rates, and lend long receiving high rates. Easy. Head to the golf course.
If the yield curve inverts, banks lose money ... their capital ratios and share prices fall ... they become more risky and less creditworthy ... people withdraw their money ... bank runs, ATMs stop working, bail-ins ... your current account is permanently unavailable (see Cyprus, Greece).
Note that many banks, especially European banks, are starting from an existing almost-bankrupt state, with plummeting share prices (DB, UniCredit, BBVA, BNP). If the EUR yield curve inverts, they all crash faster than an anvil without a parachute (DB is already giving the anvil a good race).
And I think the interest rate is inversely proportional to the amount the bonds pay or something like that?
Just explain in simple language. :)
More generally, a yield curve inversion is when the interest rate you earn on short-term debt ends up higher than that of long-term debt of the same quality.
I don't think the issue is that the inversion causes the recession. It's more an indicator of pessimism in the market. It implies that investors think that interest rates are going to get worse, so they look to buy more longer-term bonds in order to try and lock in current yields for a longer period of time. That increases demand for those assets, which drives down their price^H^H^H^H^H yields.
I'm not an economist but this seems wrong
Buying a bond means you are lending money now, in return for more money later. The amount you get later is made up of the price you pay now plus the interest, ie the yield. So if the yield goes up, the price goes down. (You don't have to pay as much for a bond when the yield goes up).
This is categorically not true. If it were then Congress would pass legislation ordering the Fed to buy securities from the Treasury at whatever rate it liked (or abolish the Fed altogether and just directly spend money into existence). Congress in fact wants to provide savings vehicles, it's not actually necessary for Congress to borrow to fund the federal government. Sure it's necessary under current law but Congress by definition can change that law. That it chooses not to is an expression of a preference.
Or is it simply about interest rates, I guess, since higher interest rates cool the market and lower interest rates warm the market. So investors are thinking a recession is coming and the Fed will need to lower interest rates to stimulate.
But, in a recession, the stock market tends to nose dive, which prompts a lot of people to flee to fixed-income securities because they're viewed as being safer. Which would also drive down yields.
Not always:
https://en.m.wikipedia.org/wiki/United_States_federal_govern...
"Market consequences ... U.S. treasury bonds, which had been the subject of the downgrade, actually rose in price and the dollar gained in value against the Euro and the British pound, indicating a general flight to safe assets amid concerns about a European debt crisis.[31]"
Basically, no one believes rating agencies with respect to the US paying its debts - but they do believe that if the US government is in chaos, it will be bad for the world economy.
One should also remember that US bonds are denominated in US dollars, which the US government can print. Also, if you're comparing to "cash" you probably mean "US dollars" which are backed by the "full faith and credit" of...the US government.
Bond prices go down when interest rates go up. As such, an investor who thinks that interest rates will go _up_ will reallocate from long-term bonds to short-term bonds, rather than the opposite as you stated.
However, when the market expects that maybe interest rates will be falling in the near future (like in a recession), it can prefer to lock in the current rates for a longer term. When markets expect recessions, people tend to buy long term treasuries over short term treasuries which causes the yield of long term treasuries to go down and the yield of short term treasuries to go up.
> Click here for a QuickTake on the yield curve
https://www.bloomberg.com/news/articles/2017-12-11/the-yield...
https://www.nytimes.com/2018/06/25/business/what-is-yield-cu...
The general reason people think rates will go down in the future is if a recession is coming, and the govt will lower them. In this case the rates may high for 2 years, but lower long term. (The 10 year rate is just a weighted average of interim rates)
The Yield Curve™ is the difference between the yields of two treasuries -- in this article it is the 5-year Treasury note minus the 3-year Treasury note. When this difference is negative that means the 5-year note has a lower yield than the 3-year note.
Investors typically want the highest yield possible, so they'll invest in the 3-year note rather than the 5-year note. A negative spread (difference) can indicate that investors are more confident about the short-term than the long-term.
Note there isn't really a single "Yield Curve". You can take the spread between any two terms of a Treasury note -- e.g. the 30-year and 10-year or the 10-year and 2-year notes. The Federal Reserve provides a spread for the 10-year minus 2-year: https://fred.stlouisfed.org/series/T10Y2Y
Although there is enough variety in the details of government bonds that you could argue there is more than one there. The proposition that there is a single yield curve is more obviously true for things like interest rate swaps.
https://en.wikipedia.org/wiki/Yield_curve#Relationship_to_th...
"Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed."
A 5-year bond now has a lower yield than a 3-year bond? How is that even possible? Wouldn't anyone who wants a 5-year bond just buy a 3-year bond and then put the cash under their mattress after 3 years?
Is the idea that in 3 years' time, negative interest rates will be widespread, physical cash will be abolished, and figuratively keeping the cash under your mattress isn't even possible?
EDIT: And why don't arbitrageurs buy up 3-year bonds and sell 5-year bonds?
Today's rates show the 3-year yielding 284bps and the 5-year yielding 283bps (the same as the 2-year) [1]. Let's consider three hypothetical buyers' outcomes. To keep things simple, we'll assume interest isn't re-invested.
One buys the 5-year. $10,000 of their principal would turn out $1,415 in interest [2]. Another buys the 3-year, keeping the principal as cash on redemption. $10,000 of their principal turns into $852 in interest [3]. Immediately, you see why the 5-year is a better buy for a 5-year investment horizon than the 3-year.
Consider a third buyer. They buy the 3-year with the aim of re-investing. To get the $563 difference between the 5-year and 3-year total interest pay-outs, they would need to buy a 2-year bond yielding 282bps when the 3-year matures [4]. If rates are lower 3 years' hence, the 5-year investor will have done better. If rates are higher, the 3-year buyer with intent on reinvesting will have done better.
This reinvestment risk, which incorporates the market's views on future interest rates, is what the yield curve essentially reflects.
[1] https://www.treasury.gov/resource-center/data-chart-center/i...
[2] 2.83% x $10,000 x 5 years
[3] 2.84% x $10,000 x 3 years
[4] [($1,415 - $852) / 2] / $10,000
So the overall yield is not lower, just the annualised yield.
That doesn't sound like nearly as much cause for alarm.
What this means is that the bond market thinks available bond yields for cash-on-hand will be lower in three years than five, so they're willing to take a hit now to lock in the longer-term payout. That reflects serious economic pessimism.
We should instead talk about it in terms of expected instantaneous, or at least short-term, forward rates. For example, what is the expected rate for a three-month T-bill starting 1, 2, 3, 4, or 5 years from now?
So, why does this happen? Well, it happens when the markets expect interest rates to drop between now and five years from now.
Why might that expectation exist? Well, it might if bond buyers were anticipating a recession.
At least that is how I understand it. Feel free to correct me.
Your confusion is precisely why it's a bad thing. Ideally, longer-term bonds have a higher yield, as that would mean we collectively are investing in high growth over a long period of time. That is, the economy grows.
When the inversion happens, then the short-term bonds have a higher yield, which means something is wrong with the economy in the long term. We don't know what's wrong with it, it's just a signal.
As the same time, the Fed is raising short term interest rates using its tried-and true headline short-term interest rate target.
This is not just unusual - it's unprecedented. QT has the effect of suppressing the yield curve inversion signal (by artificially increasing long-term rates). As a result, the gap between the next yield curve inversion (the one mentioned in the article hardly qualifies) and the next recession could be surprisingly short.
Backing off now on QT and short term raising, with unemployment at a very low point and inflation ramping up, would be lethal to the Fed's credibility. Whatever Powell says to try to talk the stock market up, he's locked and loaded and can't do much beyond stick with the program: triggering the next recession.
[1] https://www.bondbuyer.com/articles/powell-doesnt-see-high-re...
(Yes yes I know don't time the market)
i.e they could, but the long end yields will drop below where they are now, on top of signaling to the market that things are worse than what is admitted if they have to stop.
This event reflects the relative preference of the markets for the 5 yrs compared to 3 yrs, producing lower effective yields. This is probably done to secure a certain rate for a longer period of time.
Some banks keep saying 2020 is the big one since that's when most of the corporate debt will be need to rolled over onto higher rates, but I'm of the mind we don't even make it that far because of even shorter term liabilities (think corporate buybacks with debt at higher rates that will increasingly put pressure on balance sheets m/m, liquidity pressure risk assets, devaluation on collateral) in this environment.
Profits: it took about two years peak-to-trough for profits/GDP to correct during the past two recessions. Unless you see sudden stop risk, this suggests the US corprorate sector isn't staring down the barrel of a massive deleveraging...yet.
Politics: public support for legislative non-compromise does not speak to the kinds of policy fixes applied in 2008-9. Executive belligerence toward the Fed doesn't seem helpful either. As much as markets may have appeared to ignore US political risks while momentum was positive, it seems credulous to think this more of a divorce than a separation.
There are other quantitative arguments that the turn in the cycle is not here yet (e.g. employment, notwithstanding participation rate). But the prospect of a return to political gridlock is, to me, the most important risk contrast with recent past cycles.
I can think of a few explanations for why long term yields are going lower:
1. Long term yields going lower because there are far fewer places for capital to go to besides US treasuries, indicating slower business activity
2. Short term yields going higher because no one wants to buy short-term treasuries because there's something else to invest in or expect higher return for short term investment?
Are these the only two reasons? Why are people so fearful of inverted yield curves?
During recession scenarios, the Fed cuts interest rates to facilitate borrowing and inject more capital into the economy. So a lower 5yr rate means the market is expecting a more aggressive monetary policy in 2023
(I am not an expert and could be wrong.)
But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to be through the roof.
-Increase output (more people working/getting paid)
-Decrease economic investment (investors put dollars in treasuries instead of private sector projects)
-Increase interest rates (fewer investor dollars to go toward private sector projects, since some have been diverted to government debt/production)
However, the Fed usually tries to account for this force in their monetary policy (see monetary offset):https://www.bloomberg.com/opinion/articles/2018-07-20/fed-im...
I thought the Fed simply buys only a small portion of US treasury debt (thus printing money) but the vast majority of that treasury debt is purchased by holders of US dollars (banks, funds, China, Japan etc.)
Here's how I think it works:
-In theory, the Federal Reserve targets average inflation of 2% (along with its unemployment mandate)
-When the US government runs a deficit, the government sells bonds and uses the dollars to pay whatever it's paying for
-This process soaks up dollars from investors and gives out dollars to people, which on net lowers investment, increases interest rates, and increases GDP (see IS/LM model: https://en.wikipedia.org/wiki/IS–LM_model)
-The Fed, which aims to stabilize inflation, accommodates the rise in interest rates by setting higher target rates for its open market operations (if they fought the movement in interest rates by buying assets, inflation would rise, which is against their mandate)
If you go to a bank and ask for a credit for starting a business, if the bank approve of your project, they will credit your bank account with new money. That money is new created money.
How is that related to more or less bonds sales?
Which raises the question of "isn't every other investor?" And if that's the case, how much of that has the market already factored into pricing?
For example, I hear a lot of people in the Bay Area talking about saving up for when the next crash occurs so they can buy real estate cheap. But if there's sufficient pent up demand and capital, that can dampen the impact like what appears to have happened with the 2008 recession[1], only perhaps magnified after this bull run.
[1] https://www.bayareamarketreports.com/trend/3-recessions-2-bu...
Interest rates on constructed real-estate is also lower during slumps. Of course investors could be wrong, it happens. But buy-low-sell-high has on average worked best. It's one of Warren Buffett's key strategies (although arguable he is buy-low-and-keep).
also true that 2 years a very long time for an economic/investment hypothesis to play out
A better question for you to ask is this: what does my investment portfolio look like and when do I expect to withdraw from it? It's healthy for economies to go through credit/debt prosperity cycles, but this will be concerning for you if you (among other things) plan to withdraw a nontrivial amount of your investment fund(s) in the near future. If your employment situation is stable and you're not planning any large withdrawals, this is probably not something to immediately worry about. If you work in an industry which benefits from greater volatility, this might actually be beneficial for you.
This is an important note. If we do face another Black Swan event like the housing crisis, it may not be directly related to housing in the same way. As such, it signals a general "be on alert" from a risk standpoint. If you would be in serious trouble financially if you lost your job tomorrow, you may want to shore up your cash position to ensure you have a way to ride things out. If you feel relatively secure, you may want to free up some liquidity for opportunities that might present themselves. If you're about to buy a house, now might be a good time to move those funds out of the market, or consider the timing of your purchase altogether. These are just a few considerations.
In the long term, regular recessions are healthy, since they clear out accumulated fraud and deadweight, forcing people to make necessary but unpleasant hard decisions.