Author Topic: Yield Curve Inverting  (Read 1779 times)

orthopa

  • Hero Member
  • *****
  • Posts: 538
Yield Curve Inverting
« on: December 04, 2018, 07:28:01 AM »
I think its common investor knowledge that an inverted yield curve seems to almost always precede a recession. Time to recession from what I gather can be 5-18 months on average. Yet another sign that we are late to very late cycle. Anyone preparing or shifting the portfolio around at all? Of course market timing is impossible but it maybe prudent to start to accumulate some cash going forward or sell some high flying stuff. Something as simple as lightening up 5-10% a month would get you into a high cash position.

Ofcourse one would have to account for taxes/investment period etc but in a retirement or tax advantaged account this maybe a strategy. Fear would be missing out on some gains but it seem like we are much closer to the top then the bottom at his time.

I was too young wasn't investing as actively when yield curve inverted last time but sure would have like to have a higher percentage of cash in the 12-18 months following 2007.
« Last Edit: December 04, 2018, 07:37:11 AM by orthopa »


StubbleJumper

  • Lifetime Member
  • Hero Member
  • *****
  • Posts: 1006
Re: Yield Curve Inverting
« Reply #1 on: December 04, 2018, 07:36:13 AM »
I'm not sure that I would get too jumpy about the yield curve.  It's not exactly inverted, even if a couple of journalists decided to make a bit of hay from the two-year being a shade higher then the five-year:

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us


It might end up fully inverting, but the morning the only rate relationships that were "wrong" is that the 2-year yields 2.82% and the 5-year 2.81%.  Not a panic just yet, imo.


SJ

Schwab711

  • Hero Member
  • *****
  • Posts: 1363
Re: Yield Curve Inverting
« Reply #2 on: December 04, 2018, 08:19:29 AM »
I've always heard about inverted yield curves being bad too. I checked if the curve was inverted at any portion for each trading day between 1990 and June 2018 (data I had on hand). In 26.7%, or roughly 2 out of every 7, trading days had an inverted yield curve, at some point on the curve.

nickenumbers

  • Full Member
  • ***
  • Posts: 132
Re: Yield Curve Inverting
« Reply #3 on: December 04, 2018, 12:41:55 PM »
I would like you smart people to put the concept of an inverted yield curve into 1 Banana terms.
1 Banana= easy/simple
2 Banana= challenging
3 Banana= makes a monkey wanna scream cause it is so damn hard

Einstein said that the Order of Intelligence in ascending order is "smart, intelligent, brilliant, genius, SIMPLE."  Reducing the complex to simple is BEAUTIFUL!!


I know what an inverted yield curve is...  but there are lots of ways to think about it.

Does it mean that there is no demand for 2 yr debt because everyone is in cash, and the result is that prices of 2 yr debt have gone down and yields have gone up?

[My explanation is kinda wordy, and probably not the best characterization.]


Give this Monkey a 1 banana explanation.  Thanks.
The fastest Cheetah still waits for the lame baby antelope.  ..patience..

Jurgis

  • Hero Member
  • *****
  • Posts: 4126
    • Porfolio
Re: Yield Curve Inverting
« Reply #4 on: December 04, 2018, 02:11:04 PM »
Give this Monkey a 1 banana explanation.  Thanks.

I prefer a banana over a banana explanation.  8)
"Before you can be rich, you must be poor." - Nef Anyo
--------------------------------------------------------------------
"American History X", "Milk", "The Insider", "Dirty Money", "LBJ"

SHDL

  • Jr. Member
  • **
  • Posts: 93
Re: Yield Curve Inverting
« Reply #5 on: December 04, 2018, 02:12:50 PM »
Give this Monkey a 1 banana explanation.  Thanks.

I do have a relatively simple (and to my knowledge correct) explanation.  It does require 3 bananas, unfortunately, but the good news is that you only have to finish one at a time. 

Anyway:

First banana:  When a recession hits, central banks tend to reduce (short term) interest rates.  Their intent is to stimulate economic activity by doing so.

Second banana:  People anticipate the above, and so when they think a recession is coming, they expect interest rates to go down in the near future. 

Third banana:  When people expect interest rates to go down in the future, long term bond yields tend to decline in relation to short term yields.  This is just DCF math.

By putting these pieces together you should be able to see why yield curves tend to invert when people expect a recession is coming. 

cherzeca

  • Hero Member
  • *****
  • Posts: 1465
Re: Yield Curve Inverting
« Reply #6 on: December 04, 2018, 02:16:15 PM »

Cigarbutt

  • Hero Member
  • *****
  • Posts: 1272
Re: Yield Curve Inverting
« Reply #7 on: December 04, 2018, 03:00:36 PM »
I like grannis' work on this:  http://scottgrannis.blogspot.com/2018/11/the-yield-curve-is-not-forecasting.html
I like his work too, possibly because his ideas offer a different (and opposite) perspective.

Sometimes interesting to look back:
http://scottgrannis.blogspot.com/2014/12/gloomy-yield-curve.html
The first chart is fascinating because it appears that the gloomy market had it pretty much right in terms of the forward looking yield curve.

Mr. Grannis needs to be thanked because, reading his thoughful analyses, one could learn the meaning of the word: transmogrify
Over the years, Mr. Grannis has been expecting (and he still does) the economy to transform like a caterpillar becoming a butterfly.
But the word really has a much more of a colorful meaning: transform, especially in a surprising or magical manner.
As in: "the cucumbers that were ultimately transmogrified into pickles".
Who remembers what happened to Cinderella at midnight?

rb

  • Hero Member
  • *****
  • Posts: 2753
Re: Yield Curve Inverting
« Reply #8 on: December 04, 2018, 05:13:35 PM »
I'm not sure that I would get too jumpy about the yield curve.  It's not exactly inverted, even if a couple of journalists decided to make a bit of hay from the two-year being a shade higher then the five-year:

https://www.bloomberg.com/markets/rates-bonds/government-bonds/us


It might end up fully inverting, but the morning the only rate relationships that were "wrong" is that the 2-year yields 2.82% and the 5-year 2.81%.  Not a panic just yet, imo.


SJ
Maybe it's not fully inverting. But it's flat as hell!

rb

  • Hero Member
  • *****
  • Posts: 2753
Re: Yield Curve Inverting
« Reply #9 on: December 04, 2018, 05:21:57 PM »
Give this Monkey a 1 banana explanation.  Thanks.

I do have a relatively simple (and to my knowledge correct) explanation.  It does require 3 bananas, unfortunately, but the good news is that you only have to finish one at a time. 

Anyway:

First banana:  When a recession hits, central banks tend to reduce (short term) interest rates.  Their intent is to stimulate economic activity by doing so.

Second banana:  People anticipate the above, and so when they think a recession is coming, they expect interest rates to go down in the near future. 

Third banana:  When people expect interest rates to go down in the future, long term bond yields tend to decline in relation to short term yields.  This is just DCF math.

By putting these pieces together you should be able to see why yield curves tend to invert when people expect a recession is coming.
Let me see if I can build on that and try to take it down to a 2 banana.

You can think of a rate for a period as a collection of rates for smaller periods. So a 3 year rate is actually 3 1 year rates: a one year rate from 0 to 1, a one year rate from 1 to 2 and a one year rate from 2 to 3.

The fed lower rates during bad economic times. So let's say you have an inverted yield curve. Say in my example above the 3 year rate would be lower than the 1 year rate. That means that unless the market is wrong the 1 year rate in year 2 or 3 or both will be lower than the current 1 year rate. Which further implies that the economy will be doing less good than it does now. So an inverted yield curve it's a bad omen.