THE YIELD CURVE GONE NUTS. “..does anyone other than an economist or a TV reporter, bored out of their minds, even know or care about the inverted yield curve?” By Todd Horwitz, Bubba Trading.

 

I don’t know about you, but I can’t wait until Congress comes back and the fun can start again. I didn’t realize how much I would miss them when they took a break to recharge their hate for the other side. Life has been boring since they left to go on vacation. It used to give me a reason to get up in the morning and turn on the news. The past five weeks of trade war drama and the inverted yield curve have been unbearable.

First of all, does anyone other than an economist or a TV reporter, bored out of their minds, even know or care about the inverted yield curve? I would imagine that if you took a survey of Congress, less than 30% of the pols would be able to tell you what an inverted yield curve is, let alone what the dire economic effects will be. If you surveyed the general public, their answer would be more in touch with reality. What is a yield curve in the first place? So, what I am going to do here is to expose you to one of the most boring events in the world, the inverted yield curve.

Usually, the interest rate on a long-term bond should be the average interest rate on short-term bonds that will prevail during the term of the long bond, plus a “term premium” to compensate the lender for risks associated with lending on fixed terms for a long period. The Federal Reserve controls short-term interest rates. It does not control long-term interest rates, but it does influence them by providing guidance about its future short-term interest-rate actions and sometimes by buying and selling bonds with longer maturities. In general, interest rates should be expected to fall when the economic outlook is weak, because fewer people will be interested in borrowing money.

So, when the Fed has clearly telegraphed that it is about to cut short-term interest rates, it makes perfect sense that long-term bond yields would fall in anticipation of those cuts. Or, if the Fed appears to be in denial about the need to cut rates sharply but is expected to figure it out sooner or later, that’s another reason long-term yields would fall. But the short-term bond yields themselves wouldn’t fall until changes to interest rates are truly imminent or have already happened. So, if the president is talking about the three-month – ten-year when he’s yelling about the yield curve and the Fed on Twitter, he’s actually onto something in that the Fed could get the three-month rate back below longer rates pretty easily if it cut interest rates more aggressively.

With interest rates hovering around 150-year lows, other than the fact that you should buy a house if you can afford it, it means nothing. The yield curve inversion is only relevant when the spread goes out. If the two-year is yielding 4% and the 30-year is yielding 8% you have a normal curve. More time more risk. However, if the two-year is yielding 4% and the 30-year is yielding 2% you have a much different problem. It means that business is looking for near term problems and most likely we are about to or are already in a recession. Once again it is the market expectation that is the most important fact. In this case the market is gloomy and equity prices should fall if they have not already done so.

In this ultra-low interest rate environment whose side of the argument you are on is very likely to be right at some point, but that could be two years from now. As for me, forget about the inverted yield curve and bring back the good stuff, billionaire pedophiles, Nancy and the Donald, football season and hockey starts in six weeks. Let’s have some fun and forget about the inverted yield curve!

Todd “Bubba” Horwitz

Financial Markets and Political Commentary
 

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About the author

Todd Horwitz - Author of “Average Joe Options“. Todd began his trading career in 1980 at the CBOE. He was one of the original traders in the OEX & helped start the SPX. He is a member the CME where he trades S&P futures as well as foreign currencies & is a regular contributor to CNBC, Bloomberg, BNN, Fox & many other major news networks.