Yield Curve Jitters - We're all Technical Analysts Now

[EJ]

What does this chart tell you about the future? Absolutely nothing.

From early Oct. through Nov. 23 the financial media uniformly pronounced Santa Claus on strike in the North Pole. No Santa Claus rally this year. Charts were supplied to explain why Santa was sitting it out.

When markets started to rally Nov. 23 Santa Claus miraculously appeared, his presence announced as the proximate cause. No previous calls for his absence were noted for correction. Standard procedure for the financial media is to over-write previous forecasts with new ones, on the safe assumption that no one will notice or care, because entertainment not education is the primary purpose of the financial media. I'll try to do a better job of not doing that myself than I have in the past. You can't always be right in this forecasting biz, and you learn more from what you get wrong than what you get right.

Santa didn't stay long. Yesterday he abruptly left, his sled still full of investor presents. Financial market commentators, always on the hook with audiences to supply a reason for every market move decided on the yield curve as the reason for his sudden departure, this despite the fact that there's nothing happening in the yield curve that could possibly explain such a rapid and pronounced market decline.

I encourage readers to play around with this handy dynamic yield curve app. Grab the red line on the right-hand chart and slide it round recession and market correction periods.

The first thing you'll notice is that today's yield curve is hardly doing anything dramatic. It's not even flat, never mind inverted. Its' certainly flatter than at it was before short-term rate hikes began two years ago, as you'd expect, and that is one of the inputs to my forecast that the Fed is done with rate hikes for now. But keep in mind that unlike previous episodes today the long end of the curve is also managed, and the flattening is occurring along the curve relative to a much lower managed long term interest rate structure.

I don't think the market action yesterday had any more to do with the yield curve than the short-lived rally had to do with Santa Claus. More likely something went wrong somewhere in the system. We won't know what for a while what it was, although it's a safe bet that a major player in the bond market will turn out to be the culprit.

One rather peculiar feature of today's yield curve is the precisely straight slope up from the 5-year rate out to 30. Good luck finding another point in history when that happened.

As is the case with other forecasting tools that served reliably in combination with others in the past, I think we'll find that the yield curve has lost most of its utility. It may not even be a useful predictor of recessions anymore.

That won't keep market analysts from following it, thereby making it a handy tool for investor behavior modification in an era of active Asset Price Inflation.

[vt]

Re: Yield Curve Jitters - We're all Technical Analysts Now

I sarcastically feel the private manipulators (Wall Street) has just tried to manipulate the Central Bank manipulator.

EJ has been saying the Fed has been manipulating the bond and stock markets since 2008.

Now Wall Street and the Banksters have caught wind that the Fed may decide to stop raising rates and are caught uninvested.
Could they have engineered at least a start to the 800 point decline? Even fueled it with recession talk?

The FIRE gang knows how to manipulate short term, even hourly. If they now think the decline is over, they want to pull shorts and go leveraged
long. What better than to buy scared money with false signals?

[Polish_Silver]

How did yield curve predict recessions?

Thank you for the "YC" post, EJ.

I've never understood how the yield curve flattening predicted recessions.

EJ and others please comment on these points:

1) "YC" (yield curve) flattening means the spread between short term rates and long term rates decreases or changes sign.

2) YC flattening happens because anticipation of recession causes investors to sell risk assets (stock) have and buy Long term treasury bonds, thereby
increasing the price, decreasing the interest rate rate of long term T bonds.

3) If 2) is correct, there should be some false positives and negatives, because
a) Investor anticipations of recession will not always be correct
false negative : "surprise recessions" caused by oil price spikes
false positive: people expect a recession which never happens (ie. trade war which never materializes)


b) Shifts in the yield curve could be caused by other reasons than recession fears ---increases or decreased fears of inflation, for example.

[EJ]

Re: How did yield curve predict recessions?

Thank you for the "YC" post, EJ.

I've never understood how the yield curve flattening predicted recessions.

EJ and others please comment on these points:

1) "YC" (yield curve) flattening means the spread between short term rates and long term rates decreases or changes sign.

2) YC flattening happens because anticipation of recession causes investors to sell what they have and buy cash or short term treasury bonds, thereby
increasing the price/rate of short term treasuries.

3) If 2) is correct, there should be some false positives and negatives, because
a) Investor anticipations of recession will not always be correct
false negative : "surprise recessions" caused by oil price spikes
false positive: people expect a recession which never happens (ie. trade war which never materializes)


b) Shifts in the yield curve could be caused by other reasons than recession fears ---increases or decreased fears of inflation, for example.

Again, I'd encourage everyone to play around with this dynamic yield curve app by grabbing the red line on the right-hand chart and slide it round recession and market correction periods and observe the correlation to the SP500.

In the first instance the SP500 rolled over coincident with the onset of the yield curve inversion Aug. 2000, and in the second the yield curve inverted in Aug 2007 but the SP500 continued to rise and didn't roll over until Sept.

The yield curve cannot be said to be inverted until 3-Month rates are higher than 30-yr. That hasn't happened yet. Logically, if the market price of long bonds is actually lower than the Fed manipulated price then the yield curve is distorted toward rather than away from yield curve flattening and inverting.

There's something else going on here that I'm pretty sure is related to the fact that the Fed has suppressed long rates as well as short for the first time, unlike during the two previous periods covered here on iTulip, and the market participants are a bit lost trying to assess future return on risk.

My thought is we need to forget about the yield curve. It doesn't tell us anything useful anymore.

My expectation is not that a crash will result from after a period of short term interest rate tightening, in a unique market environment that resulted the Fed's mucking about with bond market sea level, but chaotic market adjustment, a series of mini-crashes and recoveries, with the periodicity and extent managed by LDAP. If this goes on for long enough it will become the new normal for a while.

[Polish_Silver]

Re: How did yield curve predict recessions?

. Logically, if the market price of long bonds is actually lower than the Fed manipulated price then the yield curve is distorted toward rather than away from yield curve flattening and inverting.

Does it work like this?

recession fears cause investors to sell "risk assets" (stocks) and buy Treasuries. The highest yield treasuries would be the longest, so the long bond prices go up while the rates go down--the same effect as fed buying Long term treasuries.

In this case increased fear of recession has the same effect as decreased fear of inflation.

[jk]

Re: How did yield curve predict recessions?

The highest yield treasuries would be the longest, so the long bond prices go up while the rates go down--the same effect as fed buying Long term treasuries.
.

the definition of inversion says the highest yield would NOT be the longest maturities. the long bonds gain value/lower their yield because buyers expect recession to lower short and intermediate yields even more extremely than long yields in the future.

[Polish_Silver]

Re: How did yield curve predict recessions?

the definition of inversion says the highest yield would NOT be the longest maturities. the long bonds gain value/lower their yield because buyers expect recession to lower short and intermediate yields even more extremely than long yields in the future.

Was it like this in the good old days:
Expectation of recession implied an expectation that the fed would buy short Term bonds and lower the Short term rates to cure the recession.
So private sector buyers would switch to long bonds to get higher yield.
So much so that sometimes the yield curve would actually invert.

[jk]

Re: How did yield curve predict recessions?

Was it like this in the good old days:
Expectation of recession implied an expectation that the fed would buy short Term bonds and lower the Short term rates to cure the recession.
So private sector buyers would switch to long bonds to get higher yield.
So much so that sometimes the yield curve would actually invert.

the curve inverted when volcker did his squeeze. short rates went to - what? 18-20? long duration had a 15 handle if i'm not mistaken.

[Polish_Silver]

YC Examples and questions

this handy dynamic yield curve[/URL] app. Grab the red line on the right-hand chart and slide it round recession and market correction periods.
.

I am trying to understand some examples of the YC.

To use the app, click in the stock chart, above the date you want. The yield curve for that date will appear.
Then use left/right arrows to get the exact day you want.

It is more clear that the FED is lowering rates than that the net effect is flattening. I haven't seen any flat or negative yield
spreads since 2008. There was actual inversion in 2000, (at rates >5%). I have not seen any flat curves in the last decade,
or rates higher than 4.5%.

A pity the graph does not cover 1970-1985---at least 3 recession, interest rates to the moon, gold peak Yeah!


7 september 2000: yield curve inverting, S&P at peak, about to go down roller coaster. Fed & markets have anticipated recession, causing
yield curve inversion.



july 28, 2003: S&P climbing quickly, large spread in interest rates. Normal recovery.




Dec 2006: YC already broken? Curve is flat to slightly inverse, but stocks are still climbing!




August 2017: Yield curve has small positive spread, but rates are very low, even though stock prices are climbing