Comment by cs702 | Hacker News Reader

Comment by cs702 | Hacker News Reader

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For context, this has happened before, prior to recessions, as shown here: https://fred.stlouisfed.org/graph/?g=mtiz

However, this is the first time this kind of yield inversion has occurred right after the Fed announced plans to stop reducing its balance sheet, which grew to unprecedented levels in response to the financial crisis. You can see the enormous impact that the Fed's balance sheet growth had on the monetary base here: https://fred.stlouisfed.org/graph/?g=lIdk

Until recently, the Fed had been reducing its balance sheet by up to $54B/month; it announced plans to stop.[a][b] How and to what degree has this impacted yields?

As additional context, consider that the yield inversion has occurred during a rise in import tariffs, trading restrictions, and public threats between the US and China (and now Mexico too). So far, the economic impact of these trading spats on the US economy has been small.[c] Could the recent yield inversion be caused more by a global flight to safety. in conjunction to the Fed's actions, than the actual risk of a US recession?

Is it even possible to answer these questions with certainty? I'd be leery of any predictions for the US economy based solely on this recent inversion of the yield curve.

[a] https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

[b] https://www.reuters.com/article/us-usa-fed-balancesheet/fed-...

[c] https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-...

> How and to what degree has this impacted yields? Is it even possible to answer this question with certainty?

To reduce its balance sheet, the Fed has rolled down assets, allowing them to mature. By choosing to not reinvest the principal from these matured assets, they reduce the size of the balance sheet. My understanding is that the reinvestment occurs in longer dated securities, which would put flattening pressure on the curve. Estimates indicate a reduction of these purchases would raise 10y yields 40-60bps [0]. All other things being equal, this would lead to steepening of the yield curve.

> I'd be leery of any predictions of recession in the US based solely on yield inversion.

Not all yield curve inversions have preceded recessions, but almost all recent recessions have been preceded by yield curve inversions. Yield curve inversions lasting 10 days or longer tend to have more predictive power. The inversion in March did not last that long, for example. On average, a recession follows 14 months after an inversion [1].

[0] https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc...

[1] https://www.advisorperspectives.com/articles/2019/04/01/a-hi...

It looks like a 10Y-3M inversion has predicted each of the last 3 recessions by about a year with no false positives in the last 35 year.

https://fred.stlouisfed.org/graph/?g=o4ro

Of course maybe this time is different...

Assuming you use 0 as your magic ball number. Move the magic ball number up just a tiny bit to 0.07 and you would have had a false positive in september 1998. You could also move it down to -0.32 and you would still a 100% success rate, albeit with a sample size of 3...

It’s dangerous to reason about this without a white board, but I think that means the negative difference between 10y and 3 mo would be decreased by the fed not reinventing in long term securities.

> I think that means the negative difference between 10y and 3 mo would be decreased by the fed not reinventing in long term securities.

When the value of the spread between a long dated (e.g. 10Y) and a short dated (e.g. 3m) instrument increases, the yield curve is referred to as 'steepening'. When this spread decreases (even when becoming more negative), the curve is said to 'flatten'.

  / steep
  - flat
  \ even flatter

They recently announced they would stop doing that.

How has that affected expectations and behaviors?

> They recently announced they would stop doing that.

I'm aware. Markets are forward looking. As you can see, yields have dropped precipitously since the announcement, and the curve has flattened. This is consistent with expectations of increased purchases of securities in the tail end of the curve.

Yes...and therefore, this recent yield inversion may not be related to growing risk of recession in the US. Maybe it is, maybe it isn't. I don't know. That's why I'm leery of predictions made based solely on the inversion of yields. Things are different this time.

That's my point :-)

> this recent yield inversion may not be related to growing risk of recession in the US

It's been a reliable signal in the past, but perhaps this time is different.

Interestingly, some economists postulate that such an inversion may be somewhat causative of recession, due to increased short term funding costs relative to long term funding costs.

> It's been a reliable signal in the past, but perhaps this time is different.

Yes, we're in agreement :-)

> Interestingly, some economists postulate that such an inversion may be somewhat causative of recession...

That could be true... I don't know.

Usually when the economy heats up, the Federal Reserve raises interest rates to cool it down.

Then in a recession, the Fed reduces rates to heat it up.

Historically, interest rates drop 5 percentage points in recessions.

But since rates are currently just north of 2 percent, there's no room to maneuver. If a recession hits now, the Fed cannot drop rates 5 percentage points. They'll run out of ammunition at the zero lower bound.

> They'll run out of ammunition at the zero lower bound.

QE showed that the Fed has more options than lowering interest rates.

> But since rates are currently just north of 2 percent, there's no room to maneuver. If a recession hits now, the Fed cannot drop rates 5 percentage points. They'll run out of ammunition at the zero lower bound.

There's no reason rates cannot go negative. Bund yields (Germany) are negative currently [0]. As a matter of policy, there are other approaches that may be taken. A modified Taylor rule with a zero lower bound may deliver optimal policy if the neutral rate falls below zero [1].

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

[1] https://www.albany.edu/~bd892/Papers/TaylorRule.pdf

Hard to see the Fed go to -3%, though.

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