Analysis:
Toward Full Yield Curve Inversion
An inverted yield curve occurs when long-term Treasury debt yields are lower than short-term yields. Normally, as the term to maturity of bonds lengthens, the yields they provide investors increase, thereby making a graphical representation of maturities of bonds against their yields a smoothly upward-arcing curve. A fully inverted yield displays the opposite behavior: the curve arcs downward from left to right. During a volatile period as the economy moves from relative health to a stage where a recession could come, the yield curve can display "partial inversion," wherein the curve arcs upward for very short-term to short-term yields, then perversely downward from left to right over the short- to intermediate-term bond maturities before recovering the normal, upward-arcing shape from intermediate- to long-term maturities of the bonds being tracked.
In the article, "Yield Curves 2005," published here, the yield curves at the beginning and end of last year were featured. The main graphic from that article is presented below.
In the graphic above, the purple yield curve for the first trading day of last year displays the classic, upward arc; by the last trading day of 2005, however, the yield curve had dramatically flattened and partially inverted, warning investors and government economic planners of a possible full inversion and the potential for a subsequent recession.
In the January 18, 2006, article entitled, "Yield Curve Inversion 2006," here at The Dark Wraith Forums, the progress of the partial inversion was shown: at that date, the yield curve was displaying a troubling, classic partial inversion, looking like a roller coaster with very short-term to short-term yields rising smoothly, short-term to intermediate-term yields falling precipitously, then intermediate-term to long-term yields again rising.
Based upon data provided by the United States Department of the Treasury, the graphic below presents the yield curve as of the end of trading on the last day of February, 2006. The yield curve from the January 18, 2006, article and the yield curve at February 1 are included for comparative reference.
The blue curve of January 18, 2006, was partially inverted: the intermediate-term to long-term yields were still rising, with the 20-year Treasury bond continuing to offer investors a better return than any short-term Treasury instrument. By the first day of February, that was still the case, but the entire curve had shifted upward as interest rates on all maturities had risen. By the end of February, the curve had generally shifted even further up, but the 20-year Treasury bond yield had begun to sag noticeably.
Using the peak yield, which has been at the 6-month Treasury note, as the base for comparisons, the spread between it and the 20-year Treasury bill yield for the three curves is as follows (one basis point is one one-hundredth of a percent):
6-month T-bill: 4.46% 20-year T-bond: 4.58% Yield spread: 12 basis points
6-month T-bill: 4.60% 20-year T-bond: 4.77% Yield spread: 17 basis points
6-month T-bill: 4.74% 20-year T-bond: 4.70% Yield spread: —4 basis points
In other words, by the end of February, the 20-year Treasury bond yield had finally fallen below the yield on a mere 6-month T-bill. At this point, only parts of the curve remain non-inverted: in the range of the very short-term, 1-month and 3-month T-bills, which may persist for a while at slightly lower rates for technical reasons; and narrowly in the 5-year to 10-year range. For all intents and purposes, however, as of February 28, 2006, the yield curve had nearly fully inverted; and while the dynamic of the curve had been moving in this direction for months, the Bush Administration and its Republican allies who control the Congress continued to press their claim that the economic policies of tax cuts biased toward the wealthy coupled with deficit spending on war of opportunity at the sacrifice of major cuts in domestic programs was correct policy.
With yet another near-record federal budget deficit now predicted for this year, the government would have little room to provide counter-cyclical fiscal stimulus directed toward middle-class and working poor households and small business; and even if the Republicans who control the federal government were to radically alter their priorities away from their natural base of support in large corporations and the wealthiest people, any counter-cyclical policies enacted now would have their effect felt far too late to stave off what could be a severe recession starting near the end of this year or early next year.
The Dark Wraith Forums will deliver continuing coverage on the yield curve as its deepening inversion becomes evident even to the most dull-witted of the incompetent neo-conservatives.
Published 3/01/2006 05:54:00 PM
<< 26 Comments Total
Good evening Dark Wraith,
I am no economist and cannot come to you from an expert point of view on these matters of yielf curves.
But I had a question for you:
Does a short term yield on a t-Bill that is higher than the yield on a long term t-bill indicate a desperation by our government to borrow more money in short term?
In other words, does the short term rate rise to help entice investors in to the short term investments because the government needs more money in short order?
I don't know if I am explaining clearly what is going through my head.
I heard recently from Robert Reich on radio program that the US is borrowing $2 billion a day to stay afloat.
It seems to incentivise such short term investments that the gummit may give a better yield to attact investors.
Good evening, PoliShifter.
You're showing more financial economics understanding than you claim to hold.
To some extent, there might be an argument that the Treasury is pounding out the quick-liquidity paper. The problem is that it's so easy to move this stuff into the market that it's not even worth calling auction bait. Fueling this is the fact that the Federal Reserve needs piles and piles of these short-term instruments because it's the T-bills that the Fed uses to buy and sell cash money from the banking system to control (or try to control) the money supply.
Imagine how thrilled Greenspan was by the end of the Clinton era when the government was no longer borrowing any money whatsoever. The Fed's supply of paper to trade for money in the banking system was gone.
On another point for a moment, the Treasury has just re-introduced the old, 30-year bond that had been put to its grave back during the Clinton Administration. Interestingly, at least from what I'm seeing, the market for those isn't all that complete yet: their prices are strange compared to everything else, and I'm not including them in yield curves yet because there isn't enough market depth in them for any reliable comparison with shorter-term instruments.
Now, I shall concede that there is some heavy push of the short-term stuff right now. The government is pushing the supply of the instruments outward, which causes their prices to fall and their yields to therefore rise. Couple that with the fact that the Federal Reserve really has direct control only over those short-term Treasury instruments, so when the Fed wants interest rates to rise, the effect is going to be much more direct on the short end of the yield curve where the Fed can actually to some extent control supply and demand conditions for the instruments driving the yields. Further out on the yield curve, the Fed's influence is only indirect: the short-term yields are embedded in the longer-term yields, but other factors come into play out there.
The fact that the long end of the yield curve is falling means that the prices of those long bonds are rising. That's due in large part to the demand conditions for long-maturity, less liquid instruments that offer the safety of those 10- and 20-year bonds. That's the "flight to quality" about which I've previously written. Investors fearing short-term bad times move their money out of relatively riskier, short term investments (like stocks) and into the safety of long-term, government backed debt instruments. As the demand for these latter products surges, their prices go up, and their yields march down in step. As a side consequence, the shorter-term instruments suck wind because investors don't want their money coming back at them in six months, 12 months, two years, or even five years; they want that money somewhere that it will stay put and not show back up for them to have to re-invest in conditions that could be more adverse than they are right now.
How was that for a long-winded answer to a relatively short question?
The Dark Wraith should probably learn how to say "Yes" or "No" more often and be done with his answers.
Thanks Dark Wraith...A very thorough answer indeed.
You wrote:
"The fact that the long end of the yield curve is falling means that the prices of those long bonds are rising."
Again this seems to be an attempt to discourage investors from the long term investments and encourge them to the short term ones.
I realize that this is all just market dynamics based faithfully on supply and demand...It's not like there is some omnipotent force at work in the bond market trying to manipulate the borrowing to suit their current needs....
It does however seem to be a chicken or the egg argument to me....
As long term yields decrease and prices increase then short term yields increase as prices decrease.
Which triggers which?
It seems perception of what the future economies hold is what is driving the markets.
From this point of view it seems then that since the demand for long term securities is growing thereby driving down the yields on long term t bills that the majority of investors are loosing confidence in the short term performance (betwen the next 2 to 5 years) of our economy.
Could this be why an inverted yield curve is often a harbinger of a recession?
OT, but these two stories may be of interest:
In today's Boston Globe.
January single family home sales in Mass. drop 21% compared to a year ago, the biggest such drop since April, 1995 (but condo sales still climb).
- oddjob
Good morning Mr. Wraith,
We are all anticipating the antimated GIF file that you'll include in your next forthcoming Yield Curve Inversion post. We believe this will help the even the most dull-witted of the incompetent neo-conservatives see the change.
You might even want to consider superimposing a plot of the Rapture Index on the curve, after all at 159 it is at a new high for 2006. The conjunction of pending doom vs. holy salvation might, just might, make the neo-cons realize that it is time to pack their bags and get in line for the jesus retractor beam. This would open up a number of government posts, that in theory, could be filled with somebody with at least half a brain. By the time they realize the mothership is a no-show it will be too late.
On another note, you mentioned some time ago your idea of publishing a book related to your forum. Thought you might find this of interest.
Well - once again we have entered the realm where my exhaustion triggered dyslexia tends to make numbers and graphics resemble the ingredients for Grendel pie. So I'll simply congratulate you on your new Koufax nod, while wandering off to find something requiring less concentration. Mazeltov!
Good evening, Fat Lady Sings.
I swear, if it weren't for you, I'd never know about some of these nominations. Thank you for keeping me clued in, and congratulations right back to you for your nominations.
For those of you interested, this Koufax Award nomination is for the four-part series, "The 21st Century" in the category of Best Series.
I'm not sure how many that makes in all for The Dark Wraith Forums; but if I'm not mistaken, that was the last category of Koufax Awards, so the voting should begin shortly I would imagine.
It's certainly something to get the old blogger blood blurping, that's for sure.
The Dark Wraith encourages everyone to vote for the blog of his or her choice in each category.
Good evening, OddJob.
Actually, that data about plummeting home sales in a major metropolitan area is right on topic.
I am pretty sure that, if a recession is on the way, it won't be preceded by some catastrophic, country-wide collapse of the housing market; what we'll see, instead, is a series of leaks springing in various SMSAs, but not all at once by any means. This is because there really is no such thing as "the" housing market: there are many housing markets, and that means both geographically and by other dimensions. That means someone who looks for some giant, across-the-country, across the owner-occupied housing categories crash isn't going to see anything that genuinely dramatic, not until quite a bit of the housing market is damaged.
You noted in this regard that the article for which you provided the link explains that, although home prices "plummeted," condo deals were still doing well. The article didn't give enough detail, though, for my tastes: Massachussetts is not one market. I'd like to know the details by area within the state. That would tell me quite a bit more. If the price collapse is state-wide, that's pretty disturbing; if, however, the bulk of the drop is in the better suburbs of the Boston market, that's something else. Expensive home prices falling will have a much stronger impact on the overall numbers than more modestly priced housing elsewhere in the state. In other words, if that overall plunge was primarily the result of the floor falling out from under the very high-priced homes, but less expensive dwellings have not (yet) experienced the collapse, that's of slightly less immediate concern, and it gives policy planners time perhaps to do something (although little really can be done, I know) to control the fall.
I did find in that article a comment by one realty industry rah-rah person somewhat amusing: he was bragging that home mortgage loan rates easing in January to their lowest level "in months."
Well, duh. If people aren't coming in to secure such loans, of course lending institutions are going to back down on rates to the extent that they can to bring prospective mortgagees in. Moreover, if you look at the long end of the yield curve, the longest rates on Treasury bonds are slipping relative to other bond and bill rates. Across the economy, that means rates on long-term borrowing will tend to have some room to maneuver downward if lenders need to offer attractions to induce long-term borrowing.
Sheesh.
The Dark Wraith wishes journalists would pick up on those kinds of things.
I don't know if it's truly broad and deep or not, but I doubt that a dropoff in only high end home sales could account for such a large drop in sales of single family homes. If it had I can't help thinking it would have been newsworthy in its own right, and I would have caught something like that. I'm a townhouse mortgage holder (only a fool calls himself an owner when what he's really done is "purchased" a mortgage) and I pay enough attention to the local real estate market that I think I would have noticed something so striking.
My impression is that homes generally are not moving as well as they were a year ago. This is wholly consistent with the Fed's raising interest rates unless I'm much mistaken. Certainly the interest rates offered around here for mortagages and mortgage refinancings have gone up. In such a market environment it seems to me the first people who will drop out aren't the wealthy but the ones barely able to consider a purchase in the first place, and they would be the ones on the low end. That condo sales & prices have continued to rise is consistent with the this idea since condos are cheaper and they offer a way to "own" at a significantly lower price.
I can't afford to live in a home here unless I purchase a fixer upper (not handy) or live in a less than desirable neighborhood. Once in every few months I stumble into an ad for something that sounds intriguing, but it's not intriguing enough for me to change my present life circumstances. In other parts of the country I would find far more to choose from, but I love Boston and I don't wish to change where I live at present.
- oddjob
I can tell you Massachusetts is quirky in that it's such a small state that the Boston metro area enormously dominates its economy, including its real estate. I've been here eleven years now and during that time I've never heard anything good about Springfield at all. If I understand correctly the real estate market there is declining and has been more or less the entire time I've been here. Even the upper end of Cape Cod is slightly affected by Boston's housing market and the scarcity of affordable homes. New Hampshire has benefitted from this problem for many years now, since at least some time in the 1980's (albeit I'm sure there are old timers there who loathe having all the newcomers from Boston, many of whom probably still have politics too liberal for the old timers' tastes). The real estate markets along the New Hampshire sounthern border have benefitted enormously from people moving north out of Boston. Even some of the down and out mill cities (Lowell, Lawrence, Haverhill) up near New Hampshire are doing better than they did 20 years ago if I understand correctly. They are doing so because people can afford to live there, but not in closer places like Peabody, Wakefield, or Andover.
- oddjob
(BTW, of those last three towns I mentioned off the top of my head only Andover is high end; the other two are firmly middle class.)
- oddjob
Good morning, Mr. Goat.
I wanted to thank you for the link to that publishing service. That would, of course, be the last resort publisher if, by the time I'm finished preparing the submission draft, I cannot find a regular publisher and I cannot afford a vanity press run. It looks to me as if it would cost well in excess of $50 wholesale with that print-on demand service. I doubt if I could sell more than three or four copies at any kind of mark-up at all over that. However, it's definitely out there as my last resort.
Fortunately, slogging through all of the old stuff to put into the manuscript is time consuming beyond my expectations. I've edited quite a bit before, but this is an editing/enhancing gig; and I'm just amazed that so many grammatical errors, awkward sentences, and even misspellings got by me in posts. Also, fitting a selection of the "Quoth the Dark Wraith" offerings into the manuscript is proving a little complicated in terms of maintaining a flow from article to article. I think I have a better idea of how to do it than the way I've inserted them so far.
I'm a few weeks away from making a submission. If worse comes to worse, that print-on-demand service will be the way I go. Again, I do appreciate the heads up on it.
The Dark Wraith slogs onward toward literary irrelevance.
This post has been removed by the author.
after reading my comment I think it was wise to rewrite it...holy cow.
Oh wise one….
Is It possible that the way Americans invest (short term) is what is driving the short term yield to be higher then it normally would for long term investing?
Maybe it is a stretch, but it seems as Americans (more generally speaeaking Wall Street) goes we have become short sighted on returns and are unable to see past our noses for long term investing and strategies. Unlike our trading “partners” in China who are in the middle of a 50 year plan or the Japanese who plan for the long haul as well (i.e. Toyota)Just a thought
It seems my question ond Polishifter are similar, however I think my question is more geared to the thinking that it is not so much the Fed Driving the Policy anymore as it is Wall Street...
Is it possible that this is a case of the tail wagging the dog. Investors forcing the treasuries hand, thus shaping our current economic trends and policies?
OT, but if you're available DW, there's a thread you should check out over at Shakespeare's Sister.
- oddjob
Good evening, OddJob.
That article was way too frustrating for me. The second example, "The hot weather kind of snuck up on us," which was supposed to be one of bad grammar, was actually an example of good grammar. I have, however, seen more and more grammar police claiming that "snuck" is not a word. It most certainly is, and it's a lovely example of an old, "strong verb" conjugation.
Verbs can be classified as either "weak" or "strong" based upon whether inflection principally affects the root vowel or the ending. Low germanic languages of old tended to favor strong verbs; weak ones became more fashionable much later. As a result, some strong verbs were re-worked to become weak.
My favorite story in this regard is the one of a baseball player who, in his later years, became a sports commentator. During a game in which he was getting excited as a runner was heading for home plate, the fellow hollered out, "He slud into home!" Of course, better people listening thought him a country hick with poor grammar skills when, in fact, he was pressing into service the older past tense of the verb "slide."
Yes, good grammar is disappearing from American English usage, just as it did in most British English usage quite a few years ago. Part of that sad state of affairs is that many grammar police think they understand English grammar and usage well enough to critique others; but if they were true lovers of the language, they would understand the history of it and the amazing ways in which it has changed, sometimes for the better, sometimes for the worse.
They would also know of the many instances in which what we consider awful grammar was at one time considered proper and correct. In more than a few cases, some "rule" of grammar simply came from nowhere at the whim, misunderstanding, or behest of a "better" person who invented a rule from the whole cloth of his own mind. Some of those rules lasted so long that they long ago became legitimate, although quite often that legitimacy is governed more by who is in political and social power and the dialect spoken by them.
Did you know that "ain't" wasn't always "not a word"?
Did you know that the rule about not using double negatives arose because people who were infused of mathematical logic a couple centuries ago thought English should be like mathematics?
Did you know that the rule prohibiting a preposition at the end of a sentence popped up because an anal-retentive translator thought English should be like Latin? (Latin doesn't have prepositions, per se, so a writer can't split the preposition particle off a compound verb in Latin.)
Did you know it's better to say, "I feel good," than to say, "I feel well," since the latter should, for all intents and purposes, get the declarer slapped?
Did you know that the translators for the King James Version of the Holy Bible didn't speak the English they used in that book? The English of that Bible hadn't been spoken in probably 50 years, but the translators believed that using this older, rustic form would make the Bible sound more authoritative. In fact, their use of a dialect in which they were not entirely conversant led to some, shall we say, interesting grammatical and spelling conventions that would have made an actual speaker of that older form of English look rather puzzled.
Did you know that the English Shakespeare actually used in his plays was considerably rougher and more modern than the version in the cleaned-up editions published years after his death. These edited versions, complete with a slightly stiffer, older English are the ones from which we, to this day, draw our quotes.
Did you know that the Constitution of the United States has some of the worst grammar one could imagine? The comma splices alone have caused no end of grief, argument, and confusion with respect to interpretation of original intent. If you don't believe me, look carefully at the Second Amendment: never mind trying to diagram the sentence; just try to find where the subject of that abomination begins and ends. The comma splices cause the sentence to behave like a road that simply stops, then begins anew in another county.
Enough with the examples. I am a constant proponent of teaching children, young adults, and new college students hard-core grammar. I am thoroughly disinterested in their compositional skills if such are developed at the expense of time spent on grammar, usage, and spelling. When I ran a two-year school for paralegals and court reporters, the accreditation body ordered me to cancel my two-course sequence in English grammar. "Grammar is dead," one of the academic auditors intoned without a hint of grasp of the outrageous cliché she had just up-chucked on my curriculum.
Let me be clear, however, on what makes for good writing. Once students have mastered the "proper" way to speak and write (including an honest, on-going discussion of all the false rules, pseudo-rules, and side stories), they should be free to find every ounce of creativity possible in bending, breaking, and mangling those sacred rules. Good grammar and good writing walk hand-in hand, but that does not in any way mean that they must or even should be sewn together with no room for expression, invention, and personality of the writer, his or her background, and his or her particular manner of using the Mother Tongue.
As a final example offered for the edification of the readers, we all know that it is improper to write an incomplete sentence.
Whatever.
The Dark Wraith outens the light on this diatribe.
Well - once again we have entered the realm where my exhaustion triggered dyslexia tends to make numbers and graphics resemble the ingredients for Grendel pie. So I'll simply congratulate you on your new Koufax nod, while wandering off to find something requiring less concentration. Mazeltov!
I'll just say ditto--except it's for a different one than series. It's for Best Blog (Non-Pro).
Good work, DW. Each nomination well-deserved.
Did you know that "ain't" wasn't always "not a word"?
I think I've heard this before, but can't be certain. In any case it surprises me not the slightest. If it truly were "not a word" it wouldn't be so prevalent, particularly in some dialects. As it is all it does in American general society is serve as a status indicator (where the user is marked as lower class or not sufficiently educated, which often amounts to the same thing), even if in the dialects where it's prevalent it serves an altogether different purpose.
- oddjob
(You still should have chimed in. I love your willingness to talk language, despite the way you keep that tightly under wraps.)
Did you know that the rule prohibiting a preposition at the end of a sentence popped up because an anal-retentive translator thought English should be like Latin?
Churchill's quip on the matter says it best:
That is English up with which I will not put!
- oddjob
Did you know it's better to say, "I feel good," than to say, "I feel well," since the latter should, for all intents and purposes, get the declarer slapped?
This time I'm not following you. Why should "I feel well" get the declarer slapped? (I almost always say "I feel good" because it "sounds right", but that's just convention.)
As to mastery leading to creativity, that's no different than it is in any creative form of expression. You can't be fully creative unless you understand the landscape in which you function. That's why artists when training draw classical shapes over & over & over. When Andrew Wyeth's son Jamie began studying art seriously he took his lessons from his aunt (Caroline, another established professional artist). The first year she had him draw nothing but three dimensional shapes such as spheres and cubes.
There's no way Picasso's art would have had the same significance had he not first been classically trained.
- oddjob
Odd JOb
"I feel well..." as I can feel up (in my case) a member of the opposite sex well....FOr others they may feel well for members of the same sex or even in other cases some people may feel well for their pet goats and donkeys. I think that guy Horsley the abortion activist can attest to that...
"My favorite story in this regard is the one of a baseball player who, in his later years, became a sports commentator." --Dark Wraith
Dizzy ("Me 'n Paul 'll win 45 games this year") Dean?
"When Paul joined his famous brother Dizzy on the Cardinals' pitching staff, Dizzy predicted, "Me 'n Paul will win 45 games." They won 49, 19 by Paul, and put the Cards in the World Series, where they each won 2 more. During the September pennant drive, Dizzy shut out the Dodgers on three hits in the first game of a double-header; Paul pitched a no-hitter in the nightcap. "I wished I'da known Paul was goin' to pitch a no-hitter," Dizzy said. "I'da pitched one, too."
Good evening, Peter of Lone Tree.
None other than the late, great Dizzy Dean: the guy roared, "HE SLUD INTO HOME!!" and thereby got the sneering snickers of those who know all about proper English much better than the hillbillies, those peoples who tend to retain characteristics of older versions of their languages far longer than their more urbanized and connected counterparts.
Dizzy's verb was just fine. So was his baseball playing.
The Dark Wraith these greats mickel ought.
Good evening, Dark Wraith.
I was going to comment on the Full Yield Curve Inversion, but read your quote:
President Bush's approval rating is so low right now that he couldn't get elected dog catcher. That's a good thing: if Bush were the dog catcher, every stray dog in town would change its name to Osama so Bush wouldn't know how to capture it.
and became so amused, I forgot what I was going to say. That was pretty darned funny. Dogs are pretty smart creatures:)
(Well, maybe except Irish Setters....)
- oddjob
Good evening, Dark Wraith.
I see that Good Omens by Terry Pratchett and Neil Gaiman is currently featured in your advertisments section. A brilliantly funny novel, better even than some of the Discworld installments.
Do you choose what book shows up there, or do Barnes and Noble? I'n guessing you do, based on the fact that the ones I've noticed seem to be works that that would meet with the Wraith stamp of approval.