Author Topic: Why will yield curve inversion NOT be followed by a recession?  (Read 4285 times)

ChpBstrd

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Why will yield curve inversion NOT be followed by a recession?
« on: September 10, 2019, 02:35:59 PM »
Almost as soon as the yield curve inverted the financial press started running stories about why it was no big deal and not a recession indicator. However most of their arguments were flavors of:

a) the economy had great numbers last quarter.
b) the economy is different now [eyebrows raise in horror].
c) I have a narrative story about how a certain investor class (pensions, insurers, hedge funds) was forced to buy long-duration treasuries...

Here’s a response from Campbell Harvey, the economist who discovered the pattern (he has several more interesting posts in his LinkedIn feed):

https://www.linkedin.com/pulse/inverted-yield-curve-head-fake-i-dont-think-so-campbell-harvey

This is NOT a market timing thread or a suggestion that anyone engage in such a risky activity. What I am asking is if you disagree or are unsure that a recession is coming within 0 to 2 years, to please share your economic rationale. Why do you think the yield curve inversions are giving a false signal this time? Looking for any intelligent argument in disagreement with Prof. Harvey. Thx.

reeshau

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #1 on: September 11, 2019, 02:34:12 AM »
My first reaction, and it seems the first comments to the article, is that Dr. Harvey does not at all address US Treasury yields relative to global alternatives.  Relative to negative yields in Europe and Japan, treasuries are going to see relatively high demand.  That doesn't explain everything; there are lots of other danger signs, too, as well as "braking" effects on the economy, like multiple trade wars.

I would also paraphrase the cliche that the inverted yield curve has predicted 14 of the last 10 recessions.  Which, as indicators go, isn't all that bad.

Maenad

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #2 on: September 11, 2019, 06:06:51 AM »
I started my response and realized it sounds like I'm attacking the OP, which isn't my intent. Please read the following as a criticism of "worrying about the future" and not ChpBstrd.

My problems with this prognostication are twofold:

1. It's fairly common for someone to find a pattern that's got a high predictive value, which falls apart at the next signal point. It's like the technical analysis of stocks - it works until it doesn't. Everything changes just enough to kill the previous assumptions and their conclusions. So I treat every crystal ball with skepticism.

2. If there is a recession, what exactly are we supposed to do about it? If one starts with the assumptions that most of the people here have a healthy emergency fund, backup plans for if they lose their job, and are long-term investors that don't change their investing strategies when the chips are down, what should any of us do differently? It's not like we can do anything to stop it. There's only a handful of people on the planet that might be able to do something about it, and they sure aren't posting here.

I also haven't seen data on the following - the yield curve inversion hypothesis is that inversion is followed by a recession within 2 years. How much of the past 100 years have we been "within 2 years" of a recession? If we've had ~15 recessions in the last 100 years, that's an average of 1 every ~7 years. If they came like clockwork, which they didn't, but for argument's sake, that would mean 5 years out of 7 we were more than 2 years away from the start, and 2 out of 7 we were within, which is almost 29% of the time. That's a pretty big chunk of time.

reeshau

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #3 on: September 11, 2019, 06:30:25 AM »
@Maenad , that's kind of where I was going.  I didn't include a picture because the only ones I could find were copyrighted, but here's one from the Dallas Fed.  Inverted yield curves do precede every recession we've had since 1955.  But there are others, too.  And while it's hard to read on the graph, I think a few of the "true positives" are stretching the 2-year window, as well.
« Last Edit: September 11, 2019, 08:18:23 AM by reeshau »

Radagast

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #4 on: September 11, 2019, 08:08:21 AM »
Almost as soon as the yield curve inverted the financial press started running stories about why it was no big deal and not a recession indicator. this time?
Financial press saying it is no big deal? What financial press do you read?

I have no idea. That article includes what I have heard. The only one I could add is that it hasn’t always predicted a recession, maybe we are due a time that is not?

I do wonder if there is a recession if it will cause a stock market crash. That one is even weaker. Everyone has been backtesting their yield curve inversion plans based on the last two for a decade now, will it really be possible for another 50% market correction just like the last two? Or was the end of last year correction the sound of big players deleveraging in advance? I certainly increased my cash as a result, the little crash made me realize we might buy a house in a year or two perhaps we should scale back. I have to imagine many more did as well.

I am very interested to see how things play out in real time though.

PDXTabs

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #5 on: September 11, 2019, 08:38:55 AM »
What I am asking is if you disagree or are unsure that a recession is coming within 0 to 2 years, to please share your economic rationale. Why do you think the yield curve inversions are giving a false signal this time?

I believe that the 3m:10y yield curve is a reliable recession indicator so I do expect a recession in the next two years. Remember, it would only take two quarters of very slightly negative growth for the NBER's Business Cycle Dating Committee to call a recession.

However, I will grant that it is at least theoretically possible that the Fed will cut our way out of it.

fattest_foot

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #6 on: September 11, 2019, 08:53:36 AM »
This is NOT a market timing thread or a suggestion that anyone engage in such a risky activity. What I am asking is if you disagree or are unsure that a recession is coming within 0 to 2 years, to please share your economic rationale. Why do you think the yield curve inversions are giving a false signal this time? Looking for any intelligent argument in disagreement with Prof. Harvey. Thx.

My guess is that the yield curve is directly related to the trade war. China needs solvency and we've heard for decades that they own a lot of treasuries (even if it's a minor amount compared to US owned treasuries), so it doesn't surprise me that our yields would go down.

Really, investments worldwide have nowhere to go for a positive return right now. The US stock market is just about it. And the economy is actually doing well, despite the media doing their best to try to force a recession because of their hatred for Trump. The economic predictors for a recession aren't there (unemployment, wage growth, etc), and the market has been mostly flat for almost two years now. If anything I think we're going to see another few years of a great economy.

DavidAnnArbor

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #7 on: September 11, 2019, 09:19:25 AM »
There's already a recession in the manufacturing sector, which has contracted, but it represents only about 15% of the US economy.

SAR

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #8 on: September 11, 2019, 01:13:57 PM »
It's a fascinating set of circumstances.

Looking at the general pattern (quick eye ball rather in-depth check on the actual indicators), it appears that interest rates most everywhere are on the way down (negative territory in Japan, Denmark, Germany, Sweden), inflation is low, and house prices on the up.

Sounds familiar--people see gains in house prices and keep spending thinking they are wealthy. But when the whole thing crashes again, interest rates have no place to go.

Might be a good time to rent!

PDXTabs

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #9 on: September 11, 2019, 03:27:23 PM »
My guess is that the yield curve is directly related to the trade war. China needs solvency and we've heard for decades that they own a lot of treasuries (even if it's a minor amount compared to US owned treasuries), so it doesn't surprise me that our yields would go down.

Please elaborate. If China was selling treasuries the yield should be going up not down.

fattest_foot

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #10 on: September 11, 2019, 03:57:55 PM »
Please elaborate. If China was selling treasuries the yield should be going up not down.

My assumption was that flooding the market with treasuries would lower the yield. Supply > demand. These aren't new treasuries being issues by the Fed. And with a flood of treasuries on the market, it would depress newly issued treasuries?

Rob_bob

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #11 on: September 11, 2019, 04:55:45 PM »
Please elaborate. If China was selling treasuries the yield should be going up not down.

My assumption was that flooding the market with treasuries would lower the yield. Supply > demand. These aren't new treasuries being issues by the Fed. And with a flood of treasuries on the market, it would depress newly issued treasuries?

A high volume of treasury selling causes the price of the bond to fall which makes the yield go up.

If a $5000 bond yields 2% then it pays $100 per year, that doesn't change. If that bond price is forced down to $4000 then that $100 per year is now a 2.5% yield.

PDXTabs

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #12 on: September 11, 2019, 04:59:45 PM »
Please elaborate. If China was selling treasuries the yield should be going up not down.

My assumption was that flooding the market with treasuries would lower the yield. Supply > demand. These aren't new treasuries being issues by the Fed. And with a flood of treasuries on the market, it would depress newly issued treasuries?

All things being equal, flooding the market with treasuries would cause the price of treasuries to go down (as is intuitive). But the yield moves in the opposite direction.

When yields are going down, prices are going up, which is another way of saying that demand is going up.

Buffalo Chip

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #13 on: September 11, 2019, 05:45:45 PM »
Not a market timing topic? I sad. ☹️ At some point I’d like to get a good definition of what being an Evil and Wicked market timer means: is it anyone who isn’t 100% invested in this looney toons equities market? Or are we talking day traders? Or somewhere in between?

As for the inverted yield curve, the article is a good one. It’s always different this time, until it isn’t. The CFO survey linked to within the article is eye opening.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #14 on: September 11, 2019, 05:51:15 PM »
I would also paraphrase the cliche that the inverted yield curve has predicted 14 of the last 10 recessions.  Which, as indicators go, isn't all that bad.

+1

All squares are rectangles but not all rectangles are squares. All recessions have a prior inverted yield curve somewhere, but not all inverted yield curves lead to recessions. It might, it might not. YMMV.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #15 on: September 11, 2019, 05:58:08 PM »
My first reaction, and it seems the first comments to the article, is that Dr. Harvey does not at all address US Treasury yields relative to global alternatives.  Relative to negative yields in Europe and Japan, treasuries are going to see relatively high demand.  That doesn't explain everything; there are lots of other danger signs, too, as well as "braking" effects on the economy, like multiple trade wars.

All government debt in Germany has a negative yield. The ENTIRE yield curve is negative. And Japan isn't much better. That means that for billions of dollars searching for a positive yield, the USA is the only game in town.
A foreigner can't buy any Chinese Yuan denominated debt due to their capital controls.
There's plenty of Greek and Italian debt you can buy that has good yield. Same thing for Russian Ruble denominated debt. Good yields there. I bet that Argentina has juicy yields now too, but I'm not sure.
For some reason those with billions to park just aren't shopping in those supermarkets.

Buffalo Chip

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #16 on: September 11, 2019, 06:26:31 PM »

All government debt in Germany has a negative yield. The ENTIRE yield curve is negative. And Japan isn't much better. That means that for billions of dollars searching for a positive yield, the USA is the only game in town.
A foreigner can't buy any Chinese Yuan denominated debt due to their capital controls.
There's plenty of Greek and Italian debt you can buy that has good yield. Same thing for Russian Ruble denominated debt. Good yields there. I bet that Argentina has juicy yields now too, but I'm not sure.
For some reason those with billions to park just aren't shopping in those supermarkets.
Comment of the day.

Now riddle me this. What happens when the USA dance card is full? The US has roughly 32% of world sovereign debt.


SwordGuy

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #17 on: September 11, 2019, 10:46:47 PM »
Yield curve inversions will ALWAYS be followed by a recession UNLESS they are followed by a DEPRESSION first.

There's just one minor detail.   There might be a lot more boom times or market stagnation before either of those events happen.

On a similar note, the same situation applies to when my cat meows for food or I fart.   :)

   


Davnasty

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #18 on: September 12, 2019, 07:55:10 AM »
Not a market timing topic? I sad. ☹️ At some point I’d like to get a good definition of what being an Evil and Wicked market timer means: is it anyone who isn’t 100% invested in this looney toons equities market? Or are we talking day traders? Or somewhere in between?

As for the inverted yield curve, the article is a good one. It’s always different this time, until it isn’t. The CFO survey linked to within the article is eye opening.

Give it a rest. I've never seen anyone on these forums suggest that market timers are evil and only a small minority are 100% equities. Even those who are would generally agree it's not the only option.

I feel like you've imagined the majority of mustachians to be dogmatic equity investors so you can be the rebel, but that's just not the case.

Not to mention, arguing against market timing has nothing to do with asset allocation. If my AA was 20% total market index funds I still wouldn't try to time the market.

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #19 on: September 14, 2019, 08:41:12 PM »
It's a fascinating set of circumstances.

Looking at the general pattern (quick eye ball rather in-depth check on the actual indicators), it appears that interest rates most everywhere are on the way down (negative territory in Japan, Denmark, Germany, Sweden), inflation is low, and house prices on the up.

Sounds familiar--people see gains in house prices and keep spending thinking they are wealthy. But when the whole thing crashes again, interest rates have no place to go.

Might be a good time to rent!

There is a big disconnect between sky-high housing prices and interest rates that are screaming the expectation of severe, worldwide deflation.

In the event of deflation, real estate is close to the last asset you want to own. As rents (or implied rents) fall, the real value of your mortgage payment increases, and as demand evaporates while supply skyrockets, the price of RE falls just as it did in the 1930s.

Historically, the bond market has been right a lot more times than the real estate or stock markets. We'll see this time.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #20 on: September 15, 2019, 04:39:43 PM »
The Fed could also un-invert the yield curve at any time by selling off the bonds amassed during QE. This would push up long term rates and thus re-instate the yield curve. At the same time they would also lower their balance sheet. Up till now they've just let them roll off the balance sheet and not re-invest the money (essentially 'destroying' the money that they printed 10 years earlier).

Alternatively, China could sell some of their massive hoard of US Treasuries and thus raise long term yields in the US, although the yield curve in the USA is the least of their concerns. Doing this however, would just bring the next problem: What to buy with all those dollars? 
If they buy back Yuan, then their currency appreciates and makes exporting all that much tougher.
If they buy gold now they have an illiquid physical asset that they have to store and hope it doesn't get stolen. Also no yield.
If they buy EUR they'd be paying negative interest rate, so perhaps it is cheaper to own gold after all?
So, chances are they'll do nothing.

secondcor521

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #21 on: September 15, 2019, 10:00:55 PM »
There's already a recession in the manufacturing sector, which has contracted, but it represents only about 15% of the US economy.

Hmm.

The ISM manufacturing index did just report a value under 50 (49.5), indicating slight contraction.  That was the first and only monthly reading under 50 since August of 2016.  https://ycharts.com/indicators/us_ism_manufacturing_production_index

The unemployment rate in the manufacturing sector has been at 10 year lows, and earnings are at 10 year highs.  We also have more people working in the manufacturing sector.

https://data.bls.gov/timeseries/LNU04032232?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000008?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000001?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true

GDP from manufacturing is at historic highs.  https://tradingeconomics.com/united-states/gdp-from-manufacturing

secondcor521

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #22 on: September 15, 2019, 10:08:35 PM »
My first reaction, and it seems the first comments to the article, is that Dr. Harvey does not at all address US Treasury yields relative to global alternatives.  Relative to negative yields in Europe and Japan, treasuries are going to see relatively high demand.  That doesn't explain everything; there are lots of other danger signs, too, as well as "braking" effects on the economy, like multiple trade wars.

All government debt in Germany has a negative yield. The ENTIRE yield curve is negative. And Japan isn't much better. That means that for billions of dollars searching for a positive yield, the USA is the only game in town.
A foreigner can't buy any Chinese Yuan denominated debt due to their capital controls.
There's plenty of Greek and Italian debt you can buy that has good yield. Same thing for Russian Ruble denominated debt. Good yields there. I bet that Argentina has juicy yields now too, but I'm not sure.
For some reason those with billions to park just aren't shopping in those supermarkets.

If you want to buy national debt, my understanding is that you need that nation's currency to buy it.  So you convert some of your local currency to the target currency, buy the bond, then either wait for the bond to mature or sell it at some point, then convert the proceeds from the target currency back to your local currency.  During this time, inflation has possibly occurred in both countries and could affect how an investor views their returns.

Therefore, investors doing that sort of things need to take into account not only the current relationship between the bond yields, but also the relationship between the currency exchange rates now and when the bond matures or is sold, and the relationship between inflation rates in the two countries.  These things are then further affected by demand and supply for bonds relative to other investments, the stability of the government (see Brexit and the value of the pound sterling), government fiscal and monetary policy, which in turn can be affected by economic cycles and GDP.

I think it's all very complex.  I barely understood (simplistic versions of) the theories when I studied them (briefly) in school.  It's not as simple as just comparing 10 year Bunds vs. 10 year Treasuries.

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #23 on: September 16, 2019, 08:39:54 AM »
The Fed could also un-invert the yield curve at any time by selling off the bonds amassed during QE. This would push up long term rates and thus re-instate the yield curve. At the same time they would also lower their balance sheet. Up till now they've just let them roll off the balance sheet and not re-invest the money (essentially 'destroying' the money that they printed 10 years earlier.

I’ve thought about this a lot too, and have pulled out this possibility in discussions with people who are worried about high inflation in the future. The fed could easily remove billions of dollars from circulation by selling their bonds, which would have a disinflationary effect without the need for economy-damaging higher interest rates. This “fed put” may have set expectations that any uptick in inflation will be immediately squashed by bond selling. Furthermore, as you mentioned, dollars are evaporating from the real economy as fed-owned bonds pay interest and mature. When high inflation becomes a virtual impossibility, people’s risk calculations are affected and there is a willingness to take on more risk for lower yields.

What the fed’s bond hoard cannot address, however, is the risk of deflation. But if we flip the equation on its head, the massive national debt could be used for that purpose. In the event of deflation, the government could by fiat create dollars to fund itself or pay off its debts. This would have an inflationary effect by dumping dollars into the economy. In reality, this is already occurring.

So in summary, the presence of a massive fed portfolio and the presence of a massive national debt means the government technically has the means (political will being another issue) to quash either inflation or deflation. Some have extended this reasoning into Modern Monetary Theory, but I’m not so sure this beneficial dynamic can be maintained forever. Eventually the debt gets bigger as the asset base rolls off the fed’s portfolio. As the fed’s portfolio gets smaller, the “fed put” becomes less plausible and the risk of inflation slowly returns. The balance between inflation insurance (potential to sell the fed portfolio) and deflation insurance (potential for debt monetization) would have to be carefully balanced to be sustainable.

China does not have the ability to dump their treasuries except in the event of a massive depression or war with the US. But again, if the Chinese govt. had to do that, the US government could monetize the debt to offset the dollars being sucked out of the real economy.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #24 on: September 16, 2019, 01:32:37 PM »
The Fed could also un-invert the yield curve at any time by selling off the bonds amassed during QE. This would push up long term rates and thus re-instate the yield curve. At the same time they would also lower their balance sheet. Up till now they've just let them roll off the balance sheet and not re-invest the money (essentially 'destroying' the money that they printed 10 years earlier.

I’ve thought about this a lot too, and have pulled out this possibility in discussions with people who are worried about high inflation in the future. The fed could easily remove billions of dollars from circulation by selling their bonds, which would have a disinflationary effect without the need for economy-damaging higher interest rates. This “fed put” may have set expectations that any uptick in inflation will be immediately squashed by bond selling. Furthermore, as you mentioned, dollars are evaporating from the real economy as fed-owned bonds pay interest and mature. When high inflation becomes a virtual impossibility, people’s risk calculations are affected and there is a willingness to take on more risk for lower yields.

So in summary, the presence of a massive fed portfolio and the presence of a massive national debt means the government technically has the means (political will being another issue) to quash either inflation or deflation. Some have extended this reasoning into Modern Monetary Theory, but I’m not so sure this beneficial dynamic can be maintained forever. Eventually the debt gets bigger as the asset base rolls off the fed’s portfolio. As the fed’s portfolio gets smaller, the “fed put” becomes less plausible and the risk of inflation slowly returns. The balance between inflation insurance (potential to sell the fed portfolio) and deflation insurance (potential for debt monetization) would have to be carefully balanced to be sustainable.

China does not have the ability to dump their treasuries except in the event of a massive depression or war with the US. But again, if the Chinese govt. had to do that, the US government could monetize the debt to offset the dollars being sucked out of the real economy.

Bold mine.

Thank you for the thoughtful input. One point of clarification: the Fed is no longer reducing the balance sheet. They stopped..... this month? Last month?

Why do you say that China does not have the ability to dump their treasuries?  In 2016 (or was it 2017?) they did unload one trillion dollars worth, reducing their holdings from $4t to $3t. Perhaps we have different meanings for the word 'dump'?

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #25 on: September 17, 2019, 02:52:58 PM »
The Fed could also un-invert the yield curve at any time by selling off the bonds amassed during QE. This would push up long term rates and thus re-instate the yield curve. At the same time they would also lower their balance sheet. Up till now they've just let them roll off the balance sheet and not re-invest the money (essentially 'destroying' the money that they printed 10 years earlier.

I’ve thought about this a lot too, and have pulled out this possibility in discussions with people who are worried about high inflation in the future. The fed could easily remove billions of dollars from circulation by selling their bonds, which would have a disinflationary effect without the need for economy-damaging higher interest rates. This “fed put” may have set expectations that any uptick in inflation will be immediately squashed by bond selling. Furthermore, as you mentioned, dollars are evaporating from the real economy as fed-owned bonds pay interest and mature. When high inflation becomes a virtual impossibility, people’s risk calculations are affected and there is a willingness to take on more risk for lower yields.

So in summary, the presence of a massive fed portfolio and the presence of a massive national debt means the government technically has the means (political will being another issue) to quash either inflation or deflation. Some have extended this reasoning into Modern Monetary Theory, but I’m not so sure this beneficial dynamic can be maintained forever. Eventually the debt gets bigger as the asset base rolls off the fed’s portfolio. As the fed’s portfolio gets smaller, the “fed put” becomes less plausible and the risk of inflation slowly returns. The balance between inflation insurance (potential to sell the fed portfolio) and deflation insurance (potential for debt monetization) would have to be carefully balanced to be sustainable.

China does not have the ability to dump their treasuries except in the event of a massive depression or war with the US. But again, if the Chinese govt. had to do that, the US government could monetize the debt to offset the dollars being sucked out of the real economy.

Bold mine.

Thank you for the thoughtful input. One point of clarification: the Fed is no longer reducing the balance sheet. They stopped..... this month? Last month?

Why do you say that China does not have the ability to dump their treasuries?  In 2016 (or was it 2017?) they did unload one trillion dollars worth, reducing their holdings from $4t to $3t. Perhaps we have different meanings for the word 'dump'?

I would say the end of the fed’s balance sheet reduction efforts is a more inflationary stance than the previous process of steadily pulling cash out of the market by selling assets. They had to stop in response to falling yields and the risk of deflation. Markets were startled last December by the realization that the ground was this soft.

Re: China, I found where their holdings declined from a high of about $1.25T in 2016 to about $1.1T now. The following articles describe my opinion about the feasibility of weaponizing these debts.

https://www.caixinglobal.com/2019-06-18/chart-of-the-day-chinas-us-treasury-holdings-drop-to-lowest-in-nearly-two-years-101428475.html

https://www.google.com/amp/s/amp.ft.com/content/2186f98b-91bc-3e84-bed9-4d28d5ecb5d8

https://www.google.com/amp/s/www.forbes.com/sites/danikenson/2019/05/22/chinas-u-s-debt-portfolio-will-not-be-weaponized-for-the-trade-war/amp/

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #26 on: September 17, 2019, 04:17:26 PM »
I would say the end of the fed’s balance sheet reduction efforts is a more inflationary stance than the previous process of steadily pulling cash out of the market by selling assets. They had to stop in response to falling yields and the risk of deflation. Markets were startled last December by the realization that the ground was this soft.

Re: China, I found where their holdings declined from a high of about $1.25T in 2016 to about $1.1T now. The following articles describe my opinion about the feasibility of weaponizing these debts.

https://www.caixinglobal.com/2019-06-18/chart-of-the-day-chinas-us-treasury-holdings-drop-to-lowest-in-nearly-two-years-101428475.html

https://www.google.com/amp/s/amp.ft.com/content/2186f98b-91bc-3e84-bed9-4d28d5ecb5d8

https://www.google.com/amp/s/www.forbes.com/sites/danikenson/2019/05/22/chinas-u-s-debt-portfolio-will-not-be-weaponized-for-the-trade-war/amp/


hmmm.... China holds $1t in US Treasuries, but also $3t in currency reserves.
https://www.reuters.com/article/us-china-economy-forex-reserves/chinas-august-forex-reserves-rise-to-3-1072-trillion-idUSKCN1VS02L
https://en.wikipedia.org/wiki/Foreign-exchange_reserves_of_China

The wikipedia article has a chart that illustrates the decline in currency reserves from $4t to $3t beginning in 2015. It took about two years but didn't seem to roil any markets.

My question: are these $1t in US Treasuries counted among the $3t in currency reserves?
Where are the other $2t (or $3t) held if not in Treasuries? Just in a (non-interest bearing) current account at their central bank?
If this is the case (and as an aside), then with an annual inflation rate in the USA of 1% this would represent a corresponding annual wealth transfer from China to the USA on the order of $2b (or $3b).

kenmoremmm

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #27 on: September 18, 2019, 10:52:35 AM »
i am enjoying this discussion. some of you have an incredible grasp of these nuanced topics.

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #28 on: September 18, 2019, 12:36:23 PM »
I would say the end of the fed’s balance sheet reduction efforts is a more inflationary stance than the previous process of steadily pulling cash out of the market by selling assets. They had to stop in response to falling yields and the risk of deflation. Markets were startled last December by the realization that the ground was this soft.

Re: China, I found where their holdings declined from a high of about $1.25T in 2016 to about $1.1T now. The following articles describe my opinion about the feasibility of weaponizing these debts.

https://www.caixinglobal.com/2019-06-18/chart-of-the-day-chinas-us-treasury-holdings-drop-to-lowest-in-nearly-two-years-101428475.html

https://www.google.com/amp/s/amp.ft.com/content/2186f98b-91bc-3e84-bed9-4d28d5ecb5d8

https://www.google.com/amp/s/www.forbes.com/sites/danikenson/2019/05/22/chinas-u-s-debt-portfolio-will-not-be-weaponized-for-the-trade-war/amp/


hmmm.... China holds $1t in US Treasuries, but also $3t in currency reserves.
https://www.reuters.com/article/us-china-economy-forex-reserves/chinas-august-forex-reserves-rise-to-3-1072-trillion-idUSKCN1VS02L
https://en.wikipedia.org/wiki/Foreign-exchange_reserves_of_China

The wikipedia article has a chart that illustrates the decline in currency reserves from $4t to $3t beginning in 2015. It took about two years but didn't seem to roil any markets.

My question: are these $1t in US Treasuries counted among the $3t in currency reserves?
Where are the other $2t (or $3t) held if not in Treasuries? Just in a (non-interest bearing) current account at their central bank?
If this is the case (and as an aside), then with an annual inflation rate in the USA of 1% this would represent a corresponding annual wealth transfer from China to the USA on the order of $2b (or $3b).

I suppose we have to reconcile the data by concluding the foreign “reserves” which were drawn down were mostly in the form of cash, gold, derivatives, drawdown rights, etc. and that China did not reduce their holdings of treasuries proportionally.

From https://en.m.wikipedia.org/wiki/Foreign_exchange_reserves

Foreign exchange reserves assets can comprise banknotes, deposits, bonds, treasury bills and other government securities of the reserve currency.[2] Some countries hold a part of their reserves in gold, and special drawing rights are also considered reserve assets. Often, for convenience, the cash or securities are retained by the central bank of the reserve or other currency and the “holdings” of the foreign country are tagged or otherwise identified as belonging to the other country without them actually leaving the vault of that central bank. From time to time they may be physically moved to the home or other country.

FINate

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #29 on: September 18, 2019, 12:45:07 PM »
Adding the recent Federal Reserve interventions this to the mix:

https://www.ft.com/content/6c9f36e4-da22-11e9-8f9b-77216ebe1f17

I don't see this being covered much in the media. Looks like QE again, like something in the bond market is not functioning well. Anyone have insight on what's going on here, and if it relates to the yield inversion?

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #30 on: September 18, 2019, 01:14:33 PM »
Adding the recent Federal Reserve interventions this to the mix:

https://www.ft.com/content/6c9f36e4-da22-11e9-8f9b-77216ebe1f17

I don't see this being covered much in the media. Looks like QE again, like something in the bond market is not functioning well. Anyone have insight on what's going on here, and if it relates to the yield inversion?

My guess is the 10%+ one day oil price spike may have damaged some banks exposed to oil derivatives, leading to risk drawdowns and a loss of confidence in counterparties. The intervention is an attempt to prevent banks from shutting down other forms of lending in a contagious spiral.  I’ve been saying this for a decade but this is the fragile banking industry we got when we repealed the Glass-Steagall Act of 1933 back in 1999. If a 10% oil price move did this, imagine what happens if stocks, bonds, or real estate go down?

It’s not covered much in the media because no one understands, and those who do tend not to be the type who bite on the “sponsored stories” clickbait that pays for our news.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #31 on: September 19, 2019, 07:07:21 AM »
Adding the recent Federal Reserve interventions this to the mix:

https://www.ft.com/content/6c9f36e4-da22-11e9-8f9b-77216ebe1f17

I don't see this being covered much in the media. Looks like QE again, like something in the bond market is not functioning well. Anyone have insight on what's going on here, and if it relates to the yield inversion?

I've seen it reported on a few outlets, but as chpbstrd suggested (and I paraphrase) it's a bit more complex than a kardashian ass, so not too much ink is spilled. panem et circenses

https://edition.cnn.com/2019/09/18/business/ny-fed-overnight-lending-rescue/index.html

It has to do with the overnight lending, called repo. Apparently not enough money in the system to keep everything working smoothly so the Fed stepped in to provide liquidity. A simple analogy, to my understanding: You just got your paycheck (a real check) and you want to have a drink on the way home. You stop by the bar but they only accept cash. You borrow $5 (or more like $10) from your buddy, even though you have a paycheck in your pocket. Your buddy who loans you money might think you're broke b/c you don't have enough money for a single drink, even though you have enough money in your pocket (just not liquid!) to pay the mortgage, insurance, groceries, and entertainment.

@chasesfish worked in the banking industry for years. Perhaps he can chime in about the Fed and overnight repos?

I think that the billions the NY Fed injected overnight will be drained away again in the next days, but if someone who has worked in this field knows more, I'd be very interested to hear what they have to say.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #32 on: September 19, 2019, 07:31:27 AM »
I suppose we have to reconcile the data by concluding the foreign “reserves” which were drawn down were mostly in the form of cash, gold, derivatives, drawdown rights, etc. and that China did not reduce their holdings of treasuries proportionally.

From https://en.m.wikipedia.org/wiki/Foreign_exchange_reserves

Foreign exchange reserves assets can comprise banknotes, deposits, bonds, treasury bills and other government securities of the reserve currency.[2] Some countries hold a part of their reserves in gold, and special drawing rights are also considered reserve assets. Often, for convenience, the cash or securities are retained by the central bank of the reserve or other currency and the “holdings” of the foreign country are tagged or otherwise identified as belonging to the other country without them actually leaving the vault of that central bank. From time to time they may be physically moved to the home or other country.

Bold mine.

I agree that in order to reconcile the data, the only logical conclusion is that they had to have drawn down forms of reserves other than treasuries. But, it seemed to be orderly, however they did it.

I find the italicized/bold quote above to be fascinating. They are basically saying that some countries hold their reserves in the home country, which in the case of the USD would be in the USA. So, no doubt we are holding currency reserves for many other countries. FWIW, I couldn't see China letting the USA hold any portion of it's reserves. Dunno, though.

Speaking of gold reserves, the USA has far and away the most gold reserves of any other country.
https://en.wikipedia.org/wiki/Gold_reserve

Who knew that France and Italy had more gold than Russia and China?

chasesfish

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #33 on: September 20, 2019, 10:50:12 AM »
@bwall - Maybe the repo issue was an indicator of something else, but I'm on the side of "not really".  Only history will tell.  Here's my take on it.

Overnight repos are the Banks loaning excess funds out at the overnight rate.  The rate spiking up meant not enough banks wanted to lend money at that specific point in time.  Why?

- Individuals and companies had massive draw downs on their deposits leading up to the tax deadline.  All corporate taxpayers on extension had funds due.  All individuals receiving K1s from S-Corps and LLCs got them and knew what their estimated tax liability is.  Big outflow of money from bank deposits to treasury.   Less deposits to loan out (and why the treasury sends them out instead)

- Bond yields have been volatile this quarter.  Treasury yields were down, then way up, then raced down from a 1.9% 10-year to a 1.77 10-year in a day.  Banks hold bonds as part of their portfolio and treasurers play around with realizing gains instead of holding these to maturity as they approach a quarter's end.  Bank treasurers may not have wanted to loan overnight while they were trying to size up what to do with their bond portfolio before quarter end. 

- There's some truth to the comment about potential oil exposure, but its probably minimal.  We can talk about Glass Stegal, but there are 4900 banks and only a handful of them (albiet the larger ones) also have proprietary trading desks that could have exposed it.  Its more about seeing Iran attack Saudi Arabia (or something of the sort) and the majority of bank's treasurers saying "I think I'll keep my dollar tonight just in case" instead of loaning it out.

Personally, its insane to me that investors allow companies to fund themselves to the extend they do on the overnight repo borrowings and fail if they cant get them.  GE had to be saved by the government because they took an insane funding strategy.

ChpBstrd

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #34 on: September 21, 2019, 10:09:06 AM »

My guess is the 10%+ one day oil price spike may have damaged some banks exposed to oil derivatives, leading to risk drawdowns and a loss of confidence in counterparties.

And there it is...

https://www.reuters.com/article/us-mitsubishi-crude-trading-results/mitsubishi-says-singapore-based-oil-trader-lost-320-million-in-unauthorized-trades-idUSKBN1W510H

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #35 on: September 22, 2019, 09:40:51 AM »

My guess is the 10%+ one day oil price spike may have damaged some banks exposed to oil derivatives, leading to risk drawdowns and a loss of confidence in counterparties.

And there it is...

https://www.reuters.com/article/us-mitsubishi-crude-trading-results/mitsubishi-says-singapore-based-oil-trader-lost-320-million-in-unauthorized-trades-idUSKBN1W510H

Interesting article. It says the trades were unauthorized. I find it amazing how many times these huge money losing trades are always 'unauthorized'. The article itself even says that they had very good internal controls and didn't know how it could happen. I think that after the trades went sour the boss(es) threw the employee under the bus rather than accept the blame themselves.

Or, to put it another way, if you believe that the bank can lose $320million and have no idea about the trades involved until after the fact, then you should never do any business with that bank again in any capacity whatsoever.



bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #36 on: September 22, 2019, 09:43:58 AM »
@bwall - Maybe the repo issue was an indicator of something else, but I'm on the side of "not really".  Only history will tell.  Here's my take on it.

Overnight repos are the Banks loaning excess funds out at the overnight rate.  The rate spiking up meant not enough banks wanted to lend money at that specific point in time.  Why?

- Individuals and companies had massive draw downs on their deposits leading up to the tax deadline.  All corporate taxpayers on extension had funds due.  All individuals receiving K1s from S-Corps and LLCs got them and knew what their estimated tax liability is.  Big outflow of money from bank deposits to treasury.   Less deposits to loan out (and why the treasury sends them out instead)

- Bond yields have been volatile this quarter.  Treasury yields were down, then way up, then raced down from a 1.9% 10-year to a 1.77 10-year in a day.  Banks hold bonds as part of their portfolio and treasurers play around with realizing gains instead of holding these to maturity as they approach a quarter's end.  Bank treasurers may not have wanted to loan overnight while they were trying to size up what to do with their bond portfolio before quarter end. 

- There's some truth to the comment about potential oil exposure, but its probably minimal.  We can talk about Glass Stegal, but there are 4900 banks and only a handful of them (albiet the larger ones) also have proprietary trading desks that could have exposed it.  Its more about seeing Iran attack Saudi Arabia (or something of the sort) and the majority of bank's treasurers saying "I think I'll keep my dollar tonight just in case" instead of loaning it out.

Personally, its insane to me that investors allow companies to fund themselves to the extend they do on the overnight repo borrowings and fail if they cant get them.  GE had to be saved by the government because they took an insane funding strategy.

Thank you for the explanation of how repo's work. I didn't realized that banks invested in bonds. But, once you describe it, it makes perfect sense.

My question: Is the money that the NY Fed pumped into the system last week siphoned off again this week? Or this month? Or have those dollars been released into the wild never to be seen again?

DavidAnnArbor

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #37 on: October 03, 2019, 08:26:26 PM »
There's already a recession in the manufacturing sector, which has contracted, but it represents only about 15% of the US economy.

Hmm.

The ISM manufacturing index did just report a value under 50 (49.5), indicating slight contraction.  That was the first and only monthly reading under 50 since August of 2016.  https://ycharts.com/indicators/us_ism_manufacturing_production_index

The unemployment rate in the manufacturing sector has been at 10 year lows, and earnings are at 10 year highs.  We also have more people working in the manufacturing sector.

https://data.bls.gov/timeseries/LNU04032232?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000008?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000001?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true

GDP from manufacturing is at historic highs.  https://tradingeconomics.com/united-states/gdp-from-manufacturing

"a closely watched gauge of American manufacturing revealed that factories had slowed in September, marking the second straight month of decline. The reading on the Institute for Supply Management’s manufacturing index was the lowest since June 2009, the month that marked the official end of the Great Recession."

Global Trade Is Deteriorating Fast, Sapping the World’s Economy
https://nyti.ms/2nejDu2

secondcor521

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #38 on: October 03, 2019, 09:45:10 PM »
There's already a recession in the manufacturing sector, which has contracted, but it represents only about 15% of the US economy.

Hmm.

The ISM manufacturing index did just report a value under 50 (49.5), indicating slight contraction.  That was the first and only monthly reading under 50 since August of 2016.  https://ycharts.com/indicators/us_ism_manufacturing_production_index

The unemployment rate in the manufacturing sector has been at 10 year lows, and earnings are at 10 year highs.  We also have more people working in the manufacturing sector.

https://data.bls.gov/timeseries/LNU04032232?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000008?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true
https://data.bls.gov/timeseries/CES3000000001?amp%253bdata_tool=XGtable&output_view=data&include_graphs=true

GDP from manufacturing is at historic highs.  https://tradingeconomics.com/united-states/gdp-from-manufacturing

"a closely watched gauge of American manufacturing revealed that factories had slowed in September, marking the second straight month of decline. The reading on the Institute for Supply Management’s manufacturing index was the lowest since June 2009, the month that marked the official end of the Great Recession."

Global Trade Is Deteriorating Fast, Sapping the World’s Economy
https://nyti.ms/2nejDu2

I didn't read the Times article, but you (and presumably they) are correct about the ISM index.  Two months of seasonally-adjusted contraction is clearly something to notice and be aware of.

While the term "recession" has a formal definition, other similar terms such as "earnings recession" and "manufacturing recession" do not.  Also, a recession is two quarters of contraction in GDP; so far the manufacturing ISM has been below 50 for two months.

The other four statistics (with linked data above) are still in historically good shape when looking back over the past decade or so.

Whether the trend will continue into the near future, and whether this slight contraction in the manufacturing sector is the first sign of an overall economic recession is currently being debated.  I've heard many people argue on both sides of the issue, and there are statistics and theories to support both points of view.  I personally think people's (and media outlets' and politicians') political leanings can impact what they think about these questions, because they have obvious implications for next year's presidential election, as I am sure you are well aware.

Cheers!

vand

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #39 on: October 04, 2019, 03:19:19 AM »
Even the YCI is not infallable, but it has a better track record than any economist or Fed official in forecasting recession.

Another thing to look we can look at is the timing of Fed tightening/loosening cycles, from which we can see that the Fed has a nasty habit of beginning loosening right before official recessions:



The period of exception to this is the era of stagflation in the 70s and early 80s where we had inflationary recessions, so the Fed was often forced to keep raising rates in the face of the recessions. If we get a repeat of those conditions then that is a huge paradigm change from the macroeconomic environment most of us have only ever known.


This should not really be a surprise if you understand what the Fed really is... ie, not a counter-cyclical stabilising entity (which was the original Keynesian proposal), but the falicitators of "as much easy money as is possible". Inevitably they keep rates too low too long, which creates excess and malinvestments which then get exposed when credit is eventually tightened (WeWork, anyone?)

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #40 on: October 04, 2019, 03:56:22 AM »

The other four statistics (with linked data above) are still in historically good shape when looking back over the past decade or so.

Whether the trend will continue into the near future, and whether this slight contraction in the manufacturing sector is the first sign of an overall economic recession is currently being debated.  I've heard many people argue on both sides of the issue, and there are statistics and theories to support both points ....
Unfortunately, imo we are currently falling into the turkey-Christmas fallacy: Global warming imo is becoming a game changer. I strongly believe there will massive social and economic change to be enforced over the next decade, and this will limit both actual growth and growth potential. Economic contraction/recesdion/depression will be likely, I believe (as externalized environmental cost will increasingly being internalized, raising prices, reducing general demand).

Redistribution will increase to mitigate social impact, making the international financial and fiscal system more fragile, rather than less. Discussions in the EU are already moving in this direction. Perhaps the US can hold up longer, but I doubt that all past experiences and statistics will really help to properly identify the economic trajectory at hand.

As a European investor, I am getting increasingly screwed (maybe not the Swiss so much) by changing, ever more restrictive policies. I don't see any option out of this atm, just hoping for a longer timeline than a decade and literally hoping that I am unduly pessimistic.

[Tl;dr]: Just saying that looking at the rear-view mirror of statistics may lead to blind spots about the future.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #41 on: October 04, 2019, 04:36:35 AM »
As a European investor....... I don't see any option out of this atm, just hoping for a longer timeline than a decade and literally hoping that I am unduly pessimistic.

As a general rule Europeans are always unduly pessimistic! :)

Don't worry, everything is going to turn out just fine!

SotI

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #42 on: October 04, 2019, 04:40:23 AM »
As a European investor....... I don't see any option out of this atm, just hoping for a longer timeline than a decade and literally hoping that I am unduly pessimistic.

As a general rule Europeans are always unduly pessimistic! :)

Don't worry, everything is going to turn out just fine!

Hear, hear 😀

BicycleB

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #43 on: October 04, 2019, 12:05:00 PM »
Enjoying this enlightening discussion.

One day, I will understand all of it. Until then, the thoughtful remarks here are slowly opening pathways in my brain. Thanks, all.

vand

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #44 on: October 09, 2019, 03:17:28 AM »
I don't think the USSR ever officially endured a recession, FWIW.

Welcome to the People's Republic of Price Controls:

https://seekingalpha.com/news/3504572-fed-look-yield-curve-control-downturn-powell-says

This sort of lunacy is why the next crisis will be magnitudes worse than most are "expecting".

Despite what is or isn't being acknowledged, QE4 has already begun. The Fed is again expanding its balance sheet:
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

In fact, the current rate of expansion is twice as aggressive as it was during QE3 ($85bn/pm)
« Last Edit: October 09, 2019, 03:23:56 AM by vand »

vand

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #45 on: October 09, 2019, 03:30:36 AM »
Paul Cwik has as good an understanding of Tresuries Yield and business cycles within an Austrian framework as anyone, and he predicts that on the current trajectory official recession will arrive somewhere between " between October 2020 (around election time) and April 2021" the (US) economy will be contracting.
https://mises.org/wire/inverted-yield-curves-recessions-and-you

Incidentally I would recommend his video for a primerif you want to get up to speed on ABCT:
https://www.youtube.com/watch?v=49rMeA1gyO0

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #46 on: October 09, 2019, 06:20:00 AM »
I don't think the USSR ever officially endured a recession, FWIW.

Welcome to the People's Republic of Price Controls:

https://seekingalpha.com/news/3504572-fed-look-yield-curve-control-downturn-powell-says

This sort of lunacy is why the next crisis will be magnitudes worse than most are "expecting".

Nothing new here.

Since it's inception the Fed has been in the business of controlling the yield curve, sometimes with more success than other times. The quote from Powell is merely a regurgitation of the current stance from a different angle. 

There's nothing to suggest that this will lead to price controls. Anyone telling you this is either being disingenuous or doesn't understand macro-economics.

vand

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #47 on: October 09, 2019, 08:14:45 AM »
There's nothing to suggest that this will lead to price controls. Anyone telling you this is either being disingenuous or doesn't understand macro-economics.

The Fed arbitarily determines the single most important price in the economy: the price of money. Anyone telling you otherwise is either being disingenuous or doesn't understand macro-economics.

bwall

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #48 on: October 09, 2019, 08:26:33 AM »
There's nothing to suggest that this will lead to price controls. Anyone telling you this is either being disingenuous or doesn't understand macro-economics.

The Fed arbitarily determines the single most important price in the economy: the price of money. Anyone telling you otherwise is either being disingenuous or doesn't understand macro-economics.

No question about that. It's part of the reason they exist. I'm not sure I understand the point you're trying to make.

Maverick1

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Re: Why will yield curve inversion NOT be followed by a recession?
« Reply #49 on: October 09, 2019, 08:45:23 AM »
I think the slope of the yield curve receives far too much attention.