Yield Curve Is More Inverted Than at This Point in Run-Up to Financial Crisis | Hacker News Reader

Yield Curve Is More Inverted Than at This Point in Run-Up to Financial Crisis

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Simple explanation of what this means. Here are current yields on Treasury Bonds (expressed as an annualized rate)[0]:

1 Mo - 2.47

2 Mo - 2.47

3 Mo - 2.46

6 Mo - 2.49

1 Yr - 2.41

2 Yr - 2.26

3 Yr - 2.19

5 Yr - 2.21

7 Yr - 2.32

10 Yr - 2.43

20 Yr - 2.68

30 Yr - 2.87

In normal times, rates are higher for longer terms. This makes sense: the longer I tie up my money, the higher interest rate I'm going to want. However, right now, the rates are mostly inverted. For example, I'd get a higher rate on a bond with a lockup period of 6 months than I would on a bond with a lockup period of 10 years.

Typically, this sort of thing precedes a recession. Bond market investors think that a recession is coming, so they are willing to pay for longer term bonds on the assumption that rates on these will go down in the future when the federal reserve lowers rates (to stimulate the economy) and when people flee the stock market generally in order to avoid risk.

[0] Source https://www.treasury.gov/resource-center/data-chart-center/i...

Thanks for this.

Question: is there any rational reason an investor would invest in a 10-year bond when they could get a better interest rate on a six month bond?

It seems like an inversion would result in near-zero long-term bond purchases.

If an investor believes that a recession is coming soon, then they'd be willing to receive a lower interest rate in exchange for a secure 10-year return.

The fact that investors are purchasing long-term bonds at these inverted rates is exactly what indicates a possible recession. The lower price is a function of their willingness.

Sure, if you think that rates are going to drop next year, and would like to secure the 10 year rate instead of risking that.

Another way to express it: if today, you believe the average rate over the next 10 years will be lower than the current 10 year rate, you should buy the 10 year treasury.

This is a tiny bit simplistic as it ignore liquidity/volatility differences between buying a 10 year treasury and buying 20 6-month treasuries or 10 1 year treasuries.

Yes. For precisely the same reason you would choose a fixed rate mortgage over a variable rate mortgage.

NPR's "The Indicator" podcast has had a couple of good (and short) episodes about inverted yield curves. I think this is the first of them: https://www.npr.org/sections/money/2018/01/12/577710151/the-...

I highly recommend The Indicator podcast.

With a 10-year bond, the investor receives that interest rate over the whole 10 years. With a 6-month bond, the investor receives that interest rate only over these 6 months, and then has to find another bond to buy. If all available bonds then have a lower interest rate, the investor would have received more for the 10-year bond.

(What might be confusing at first is that interest rates are usually "annualized", that is, presented as if they were for a single whole year. You won't actually receive 2.49% of what you paid for the 6-month bond; you'll receive something like 1.24%, and you have to invest again for another 6 months to reach that 2.49%. If that investment is no longer available, you might not be able to do that.)

One can invest it again in a 6 month bond with the yield curve inverted further. The decrease in rates would happen over a longer term than 6 months. And also if the rates have decreased the prices would have increased for the bond that is held.

> Question: is there any rational reason an investor would invest in a 10-year bond when they could get a better interest rate on a six month bond?

Well, what do you do with the cash once the six month bond matures? IF a recession comes along, you'll be looking for a place for your cash in a financial environment that may be quite bad.

People go to 10Y bonds because any financial storms would have likely blown over by then. And keep in mind that the average time between inversion and a recession is 311 days. [1] And then on top of that you'll want some recovery time.

So you're looking at least 2 years before things hypothetically blow over. And US bonds only come in certain increments: 2Y may be overly optimistic, and the next jump after that is 5Y (then 10Y).

10Y may also be more liquid, so people just mostly skip 5Y.

[1] https://seekingalpha.com/article/4250934

Because they think it will work better over 10 years than sequentially buying two 6-month bonds, a 2-year bond, and a 7-year bond based on whatever the market rates are as each one expires.

Well the bond market thinks that the interest rates will be lower in the future than right now. And one reason that interest rates could drop is a recession.

This should be expected. Given rising FED rates over the last year+, as well as QT (quantitative Tightening, which undoes the QE in place for nearly a decade), these actions are - and this is key - reducing the money supply.

It is the reduction of money supply that causes deflation (and therefore lower rates). Technically, a yield curve inversion is an expectation of lower rates in the future, not necessarily lower growth.

This is actually extremely important, but widely misunderstood: You can have growth with deflation (and likewise, recession with inflation).

To make that point clear, a yield curve inversion is an expectation of interest rates, not necessarily an expectation of lower growth.

I expect this will cause all sorts of arguments, but the math is clear. I'll quote the Mises Institute [0] on this:

For instance, if the money supply increases by 5% and the quantity of goods increases by 10%, prices will fall by 5%.

[0] - https://mises.org/wire/central-banks-shouldnt-fight-deflatio...

I left off one clarification: it tends to be a good predictor of recessions, but is not perfect. See the inversions for the last half of the 1960's at the St. Louis Fed [0] as a counter-example.

[0] - https://fred.stlouisfed.org/graph/?g=nn5r

I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks.

Put the 10 year in context: in Japan and Germany and other stable countries yields are negative. So you have to pay to lend those countries money, because the central banks are pushing yields negative.

But in the US you can actually get a modest (but real) return on the ten year, so it’s quite popular. This popularity has pushed the price lower and flattened the curve.

And while recession may not be in the cards for the US in the next few years, the next ten years is a whole different story - so given the newfound dovishness of the Fed given European and Chinese weakness, it makes sense to lock in some yield in those ten year bonds now.

While I'm not saying you're wrong (and I'm not pretending to know enough to fully understand all the forces at play here), the article ends with the following statement that I find interesting, in light of your comment:

> Every time the yield curve inverts there is a theory about why it doesn’t matter. The stock market rallies that often follow inversions further allay fears that it really is different. In the end, it almost always ends up not being different.

"almost always"

Keep in mind this signal was only discovered in 1989. So we have a forward-looking success rate of three out of three recessions predicted within a year or two.

3/3 is great, of course, but it wasn't delivered on stone tablets from Mount Sinai. The strange thing about predictive economic indicators is they often stop being predictive once popularized.

Why? For example, in 2000 and 2006/7 the Fed raised interest rates aggressively even after the inversion. However, we know that the current Fed is looking at the curve, and has become much more dovish since the inversion. So it's entirely possible that it's predictive ability will be diminished precisely because policy makers are paying attention to it.

In the current circumstance, one argument is that the Fed overreacted in raising short-term rates, making those rates artificially high. I suppose there is some support for this without looking too deeply into it as the Fed now is unwinding QE. Unwinding QE still is "tightening" monetary policy. My guess is that the Fed believes that by lowering its portfolio's duration is a more effective way to raise longer-term yields to prevent the yield curve from becoming more inverted. I'm not a monetary expert, but I suppose you could say this time is different due to QE/QT, or you could stick with how the market typically reacts after the yield curve inverts.

> I’m not convinced this is a recession signal, as much as it’s a reflection of the new normal for worldwide central banks.

3m/10y curve inversion has proven to be a reasonable signal for upcoming recession in the USA for the post WW2 period [0]. If the Federal Reserve were to factor this signal into its decision making processes (as ECB and BoJ do), its predictive power would likely decline (can't recall the episode of the podcast Macro Musings at present for citation).

> Put the 10 year in context: in Japan and Germany and other stable countries yields are negative. So you have to pay to lend those countries money, because the central banks are pushing yields negative.

You can earn positive (nominal) yields on JGBs [1] and Bunds [2], so not all yields are negative.

> But in the US you can actually get a modest (but real) return on the ten year, so it’s quite popular. This popularity has pushed the price lower.

You're comparing outright duration to curve risk. These are distinct. When discussing curve inversions, you are comparing the spread between two points on a curve, precisely to eliminate any parallel shift component. In this case, the comparison is between a 3m investing period and a 10y investing period.

> And while recession may not be in the cards for the US in the next few years, ten years is a whole different story

On what basis do you assert that recession isn't possible in the US over the next few years? Fed funds futures currently imply a 63% chance of easing by the end of 2019 [3], indicating expectations of deteriorating economic conditions.

[0] https://www.frbsf.org/economic-research/publications/economi...

[1] https://www.bloomberg.com/markets/rates-bonds/government-bon...

[2] https://www.bloomberg.com/markets/rates-bonds/government-bon...

[3] https://www.cmegroup.com/trading/interest-rates/countdown-to...

Huh, you're right that European interest rates have done nothing but go down: https://tradingeconomics.com/euro-area/interest-rate. That could explain added demand on US long term rates, but as the article pointed out, people said the exact same thing in 2006.

Feels like capital from emerging markets is being reallocated into T-bills and co.

What do we know about long term risk and consequences regarding countries operating with negative rates? Can they be considered healthy? Or is this a sign of longer term risk they face?

What does that environment mean for Joe Consumer and their 401k?

The headline implies a claim that I don't see any support for: that degree of yield curve inversion is related to likelihood of recession. While that seems plausible, I've never seen analysis that being more inverted is a stronger predictor than simply being inverted at all.

Traders think yields will drop. Yields drop because liquidity increases. Liquidity increases because more people want to lend than borrow. A recession lowers the demand for debt, so the price drops and the yields rise. To fight the recession, the fed creates dollars and buys debt with them. The lower supply of and increased demand for debt raises the price, which drops the yield. But this would only happen if the fed was unable to control the recession. Economic expansion also raises the demand for debt. Or it could be the effect of international debt arbitrage. Or balance of trade.

Truly I have no idea what traders are thinking. And they could all be wrong.

All I know is that this is way more complicated than pattern recognition.

What can the average founder, employee, and person do in the face of this news?

I understand that it’s scary, but what can we do to turn that fear into an actionable checklist?

Reduce your burn rate (you should have no debt except a mortgage or a lease obligation). Have at least 6-12 months of emergency fund in an FDIC insured account. Network to be prepared to find a new gig fast if yours evaporates. Be prepared for credit card and home equity credit lines recinded with no notice.

I did not do these things prior to the 2008 global financial crisis, and it was unpleasant.

For example, paying down debt would be a good idea. [sound of numerous economists jumping up and down saying this would turn prediction of recession into self-fulfilling prophecy] Also, holding off on any major new purchases like houses or new cars. [sound of foresaid economists moaning and putting their heads in their hands in despair]

> For example, paying down debt would be a good idea.

Opposite from a financial standpoint: if interests rates lower in the future you will be able to refinance.

From a job-vulnerability perspective it always lowers your risk though: better not to be very leveraged if your income can fluctuate.

You'll only be able to refinance if a bank is willing. If a recession is the driver of a fed rate reduction, that seems less plausible.

It really depends on the type of debt. Don't pay down your mortgage by $10k. It will probably do nothing to lower your monthly payments. Do reduce high-interest credit card debt if possible. If you don't have high interest debt, save the money in cash or cash equivalents. High yield savings accounts are paying 2.5%. Also, do everything you can to increase your liquidity and access to liquidity. Maybe open a home equity line of credit, but don't dare spend from it! In a recession, liquidity is king. During the Great Recession, Leman Bros. went under due to illiquidity more than anything else. Whereas Warren Buffet made a killing because he could come up with cash when hardly anybody else could or would. The same principle applies to economic entities of any size.

Hedge against market risk by moving from a market index into something like a volatility index.

The cost of carry to long volatility is insane, and there's no guarantee spikes in volatility will be well-correlated with drops in the market. Don't do this unless you know what you're doing.

Don't do this. See the other response as to why.

If you're a founder and this genuinely does scare you: raise money. Assuming your company stays on the same trajectory, you can raise at much better terms now than when a recession hits, especially if said recession will impact your growth.

Yes, raise now and to be safe, assume that you will not be able to raise money again.

First thing, don't panic. (And I'm not trying to play on HHGTTG...).

So don't go rush out and liquidate all of your investments.

Second, always make sure you personally have a plan with savings for at least 6 months or more. Think about what would you do tomorrow if your source of income stopped and you had to make it for a year without any more income. How would your life style change? What sacrifices would you have to make?

Unfortunately, many people have very little to no savings and this isn't even an option.

If you are close to retiring (5-10 years or less), consult a financial advisor who you trust. At this point, you should have enough to live off of in safe/less volatile investments.

As a startup founder, I think the macro economics side is the last of your worries on a long list... you should always have contingencies for things not going right. For instance, a large company releases a competing product to you tomorrow...

> What can the average founder, employee, and person do in the face of this news?

Make sure your finances are in reasonable order in case you get laid off:

* https://www.reddit.com/r/personalfinance/wiki/commontopics

Not all economic downturns are as bad as the Great Recession was.

Similarly: I'm in my early thirties with young kids. Apartment life is getting cramped and we're ready (eager) to finally buy a home. How should this prediction/speculation factor into my decision?

You can see how fixed rate mortgages trend during periods of recession here: https://fred.stlouisfed.org/series/MORTGAGE30US

Using this data, you can make some guesstimates on how waiting might effect your home purchasing decision.

By my read, mortgage rates tend to decrease during a recession. However, mortgage rates are already very low, so the potential savings may not be meaningful.

Wouldn't the larger driver be a potential fall in house prices?

With the exception of the 2008 financial crisis, housing prices typically appreciate during times of recession, albeit more modestly. My guess is that this is primarily driven by falling mortgage rates.

"The FHFA U.S. house price index rose by an average of 7.4 percent in the year prior to a recession and prices rose an average of 2.7 percent from the start of a recession to the end" [ https://www.cnbc.com/2018/12/11/housing-could-be-an-unlikely... ]

> With the exception of the 2008 financial crisis, housing prices typically appreciate during times of recession, albeit more modestly. My guess is that this is primarily driven by falling mortgage rates

My guess is that it's a smaller market with less price sensitive buyers, based on who can afford to buy and who is therefore likely to sell during a recession (the late 00s recession being different because of the central role of the housing market collapse in that recession.)

This could also be a bet that the economy is still yet to improve, as in times of good economy the coupon rate has historically dramatically increased. To extrapolate, if the investor expects the economy to peak in 5 years, he would be incentivized to allocate capital into short-term investments such as equities and short term bonds as to defer longer-term investing until those bond yields reach their peak.

If investors were putting more capital into short term bonds, wouldn't the yield of short term bonds drop, not rise?

Yes, so in this case investors are instead placing more of their capital in liquid assets, like public equities. With investors optimistic about the economy, keeping in mind that coupon rates rise during good economies, we would expect higher yield rates in the short term with optimistic investors having both the expectation that equities will outperform those bonds (so capital is allocated away from bonds) and secondly that interest rates will rise as the economy improves. This is exactly what we see when we look at the 1-mo to 1-yr bonds.

Coincidentally, the Fed just announced that interest rates aren't expected to rise this year, so we should see a decrease in the yields of the 1-mo to 1-yr bonds.

It should also be noted that there is a delay between and inversion and a recession, with an average of about a year:

* https://seekingalpha.com/article/4250934-yield-curve-inversi...

This means it will probably occur in the middle of next year's US presidential election. :)

> next year's US presidential election. :)

Any chance the US can extend its terms? An election seems to last an entire year and be one of the most toxic events possible online.

> Any chance the US can extend its terms?

Sure. Just amend the US Constitution. No biggie. :)

> Any chance the US can extend its terms?

In theory, yes, by Constitutional Amendment. In practice, before the next election? Short of an auto-coup, no.

While technically possible, since it would require a constitutional amendment, there is no plausible scenario under which the term of the US president will be extended in the foreseeable future.

How often does it invert? Had it ever happened without a financial crisis to go with it?

According to the article, there has only been one false positive, back in 1965. Not sure how many inversions have occurred.

The specific part that just inverted has inverted before every recession since 1957 (9 times) and given one false alarm in 1965

Here's the last nearly 40 years worth of that curve, with recessions marked for convenience: https://fred.stlouisfed.org/series/T10Y3M (use the range selector below the graph to see everything)

Yes, it often inverts before recessions, but most recessions do not accompany financial crises. The business cycle is normal; financial crises are (or should be) abnormal.

More practically, at least for those thinking of buying a home on a standard 30-yr fixed mortgage, since it seems like the consensus among investors is that interest rates for long-term debt will fall it makes little sense to buy anytime soon if you can wait...

Or does it make sense to go with an adjustable rate mortgage instead?

Buy if you need/want to buy. Refinancing a mortgage after a rate decline is fairly easy and you’re likely to get a better purchase price in a (locally) high rate environment and carry that lower purchase price into your refinance. The diff in purchase price likely more than covers your refinance costs.

"consensus among investors is that interest rates for long-term debt will fall" - could you elaborate on this? Are you suggesting e.g. the rate available for a 5 year fixed mortgage is expected to fall, or that rates will fall over the next 30 years?

Fixed mortgage rates are already historically low

The current Bankrate benchmark 30-year is 4.17%.

That is, by historical standards, absurdly low. The likelihood that a rate drop will 1. occur, and 2. materially contribute to your financial well-being, is very low.

Part of the reason is that when rates drop, prices tend to rise.

https://fred.stlouisfed.org/graph/?g=NUh

I was worried for this over the past few days (thanks, YC! ;) ), and reading the thread below see others are as well, but the main solid data I could find against the yield curve predictor (which the original article doesn't mention) is that it doesn't hold up in other countries:

https://www.marketwatch.com/story/an-inverted-yield-curve-is...

So, if you're a start-up in the U.S. and are worried about the yield curve, just move to Germany, where even though the yield curve is also now inverted there, the historic evidence shows no to weak prediction of a German recession due to an inverted German yield curve!

#possibleSpuriousCorrelationFromDataMining

Has the yield curve ever gotten really inverted without a subsequent "bend over" recession following? ... IOW... is there a counter example where we can say well "maybe this time is a lot like this time?" ... otherwise sounds like the typical banker control clock in action. Good job monopoly man again! (I posses no knowledge of a better economic system)

Yes. 1965.

And then it bounced back and forth for the next 4-5 years before we finally had a recession in 1970.

https://fred.stlouisfed.org/graph/?g=nn5r

> https://fred.stlouisfed.org/graph/?g=nn5r

Note: this graph is for 10Y1Y, while the indicator generally talked about is 10Y3M.

Good point. I know that 10-2's are popular as well.

I used this one because it had the longest history.

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