You can try and play down a trade war with China. You can brush off the impact of rising oil prices on corporate earnings.Waiting for Trump to explain why This Is All Obama's Fault(tm) in 3....2....1....
But if you’re in the business of making economic predictions, it has become very difficult to disregard an important signal from the bond market.
The so-called yield curve is perilously close to predicting a recession — something it has done before with surprising accuracy — and it’s become a big topic on Wall Street. ... Every recession of the past 60 years has been preceded by an inverted yield curve, according to research from the San Francisco Fed. Curve inversions have “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession,” the bank’s researchers wrote in March.
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Monday, June 25, 2018
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There is a secondary indicator that isn’t watched much either. Sundry commodities, things like cow skins and such, have been showing weakening demand, while the news is all focused on copper and rare earths. The really ugly bit is that copper is starting to fall too...
ReplyDeletewell, what causes the yield curve?
ReplyDeletePaul, the yield curve is a mathematical construct that depicts the relative valuation of the selected bonds. In this case, the market determines the price it is willing to pay for each security, determining its yield. In short, the financial markets determine the yield curve, but that determination is based upon the underlying economic conditions and expectations. In this case, the 10 year and the 2year government bonds are the securities, and the market is no longer demanding nearly as much of a premium for a long bond (10 year) as it is for a short bond (2 year).
ReplyDeleteIn theory, the market demands additional return for a longer period, however this relationship is breaking down. The invasion of the yield curve will be when the 2 year bond is returning more than the 10 year bond. So, how do the returns fluctuate? The return of the 2 and 10 year bonds in question is fixed, so the return is adjusted by buying the bond at a premium (above face value) or a discount (below face value). A bond purchased at a discount (say a $100 bond purchased for $99) will yield more than its stated return (a 2%, 2 year bond would return a bit over $104, but if bought at $99, would return an effective $105, or close to 2.5%).
This also explains why bond funds usually lose money when interest rates climb. The bonds the fund owns are now worth less than face values, unless held to maturity. If the fund has to sell a 2% bond in a market that demands 4% returns, they have to sell that $100, 2 year, 2% bond for something like $96. All these number are rough because of compounding time to maturity, but you get the idea.
In summary, the yield curve is a market expression of the financial conditions, conditions that Donnie has taken responsibility for with great relish. I do note, however, that Donnie hasn’t been tweeting about the stock market for quite a while...
so that 100 dollar bond will be valued less, even at 96 dollars.
ReplyDeleteokay, got it.
but we're talking about overall bond market operating at BILLIONS of dollars, so the devaluation of those billions is gonna mean a lot of lost value.
when should Wall Street firms start rioting against trump? Now or tomorrow?
Paul, perhaps because the large banks and investment firms don’t tend to lose money because they have hedged the market swings. The losers are the investors, and the companies don’t really care, because they get their cut of the trades and suffer few losses.
ReplyDeleteWall Street makes money if the markets go up or down, it’s a lot like casinos. They make less money in down years, but seldom lose money.
https://www.economist.com/sites/default/files/imagecache/640-width/images/2018/06/articles/main/20180623_wwd000.jpg
ReplyDelete