Saturday, November 3, 2012

The Danger of a Flattening Yield Curve


Click to enlarge.

What makes it bad?


Click to enlarge.

Note that all of the "bad" points were followed by a recession.

On the one hand, we're currently above 0%. That's good news.

On the other hand, the 3-month treasury bills are stuck at 0.09% thanks to monetary policy. The 3-year rate is just 0.38%. How much more can we really expect the spread to shrink? Put another way, the danger signal is being distorted. There could easily be even more danger than this chart shows. That's bad news.

Yield curve

A flat curve sends signals of uncertainty in the economy.

I'm fairly certain that all is not well, especially over the long-term.

June 10, 2011
The Fallacy Of the Steep Yield Curve

Can we take the yield curve at face value if we know that the mass of transactions that make up its price discovery mechanisms are full of purchases by an entity that gives no distinction or thought to risk/return when executing bond trades? If the full value of the information content of the yield curve is supposed to be a product of millions of disagreements on the risk/return expectations, then that content is diluted by transactions that have no grounding in that primary calculus.

Dilution is probably understating the case by an order of magnitude since the Federal Reserve has been actively moving the yield curve at both ends. In other words, the Fed is the yield curve, through QE 1.0 and 2.0, and its actions have little to do with risk expectations. So how can anyone rightly say what the yield curve is telling us about those expectations?

Source Data:
St. Louis Fed: Custom Chart

6 comments:

Who Struck John said...

It's always best to screw with the signal so that then you can be completely blindsided.

Stagflationary Mark said...

Who Struck John,

We are at the outer limits of what the Fed can do.

Who Struck John said...

I'm learning not to misunderestimate the Fed.

Stagflationary Mark said...

Who Struck John,

The American people will do what’s right when they have the information they need. - Donald Rumsfeld, 1966

It will happen any day now. Count on it, lol. Sigh.

nanute said...

Markets will have to respond to the rates we have, not the rates we wish we had. Ben Bernanke riffing on Donald Rumsfeld.

Stagflationary Mark said...

nanute,

If you can't be with the rates you love, love the rates you're with. Don't be angry. Don't be sad. Don't sit crying over good times you've had. ;)