Inverted US treasury yield curve

Investing / Others
1

Hi,

I was recently reading about the US treasury yield curve and its meaning for the economy. I realized that the current curve looks a bit “inverted” or flat https://www.ustreasuryyieldcurve.com/

I was wondering what are your thoughts on the meaning of this for the markets, how this relate to the future of the economy? (I know it is a sort of stupid question).

I was first like… “Wow, the curve is inverted!” but not really as the axes do not start at zero, so the changes looks bigger than they actually are, with a proper axe it will look really flat, am I right?

2

My understanding is that, mostly, investors expect rates to go down on the longer term, so the shorter rates are higher because they’re expected not to be able to be renewed at that same level.

People usually expect a recession when the yield curve is inverted because a recession is one of those types of events that has rates cut down and yield curve inversions have been good indicators of them in the past. I think this time may warrant other options too because the rates are at the level they are because the FED is fighting inflation, and inflation is cooling, so there are other narratives that can warrant expectations of rate cuts in the medium-longer run. I note that the inversion happens somewhere during next year, which is when the FED’s guidance indicates that they may be considering cutting rates, in relation to inflation and not recessionary prospects.

I also consider that through this cycle at least (2020-now), investors’ expectations have been all over the place and pretty delusional so I don’t consider them as a good predictor for anything, except that I won’t rely on rationality to make bets on the market going forward (the safe way is to avoid bets altogether and keep buying and holding at your target allocation, which is the surest way to consistently win).

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I was reading that all these financial analysts are actually forgetting that one have to look at expected real rates (nominal minus expected inflation) to see that a recession is priced in in an inverted yield curve. So if you do it correctly, the curve is not inverted, expected short term inflation is much higher than the long term one.

But personally I don’t care.

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5

Yep, I was wondering about this just for the sake of disucssion, this kind of think won’t affect my investments. It is just helpful to understand what is going on globally.

When correcting the curve by inflation, without doing any calculation, I would expect to see the classical curve (short term low and long term “high”), am I right?

Long term bonds are at 4%, which is not a low rate at all for a bond. This mean that people is not investing that much on bonds right now as this part of the curve is dependent on what investors do, right?

For the short term, I understand that as an incentive of the Fed to cool down the economy, which doesn’t appear to be working that much.

6

The market thinks many months ahead and is already anticipating future rate cuts either if a recession happens, or if the inflation is successfully stopped. An inverted yield curve reflects this expectation of sinking rates in the future.

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7

I would find a chart or do the calculation before drawing any conclusion.

It’s not particularly high historically speaking, the low yields of the last 15 or so years are more of an anomaly than the reverse (can’t find a chart going further back for now): United States 10 Year Treasury Note Yield History

Treasuries are auctioned by the US Treasury with a defined face value and coupon, the price at which they are bought, though, is fixed by market participants (who take part in the auction). Some of those bonds then go on the secondary market where they are bought by other market participants at the price they are willing to pay.

There is an inverse relationship between the price of a Treasury and its yield: when prices go up, yields go down and inversely. The FED has a semi-direct hold on short term yields via their own rate and the discount window. They have less hold on longer term yields which are more determined by the price investors are willing to pay. However, starting 2022, the FED has started quantitative tightening which is letting expire or selling some of the longer terms bonds and mortgage backed securities that are on its balance sheet.This increases the supply of bonds and should increase their yield.

It’s hard to say current yields are 100% set by investors’ expectations, though they do play a big part in it.

Inflation is going down (though US core inflation remains high) so they are getting toward their goal (cooling the economy is one of the means by which inflation may get lower but isn’t a purpose in and of itself). What they really need is for expectations to remain anchored, and a lot of the effects of their current policy did it through people’s expectations: if I expect inflation to be high, I will want to buy more goods/services now that the prices are at the lowest level I expect them to be. I will also have higher salary raise expectations in order to maintain my standard of living. If I instead expect inflation to be tame, that takes away part of the pressure that fuels it in the first place.