Much has been made about the recent action in the bond market. Yields have fallen to unheard of levels. The inflationistas and curve steepener traders are bewildered. It’s clear that bond investors are expecting very low inflation in the coming decade, but some fear it is portending far worse. Famed bond guru Bill Gross is worried about the action in the bond markets – so much so that he says the current environment is pricing in a depression. The Cleveland Fed recently released a note on the predictive nature of the yield curve. Their conclusions – a slowdown is on the horizon, but no double dip will follow:
“Since last month, the three-month rate has dropped to 0.09 percent (for the week ending June 18) from May's 0.17, and this also comes in below April's 0.16 percent. The ten-year rate dropped to 3.26 percent from May's 3.33 percent, also down from April's 3.85 percent. The slope increased a mere 1 basis point to 317 basis points, up from May's 316 basis points, but still below April's 369 basis points.”
“Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.00 percent rate over the next year, just up from May's prediction of 0.98 percent. Although the time horizons do not match exactly, this comes in on the more pessimistic side of other forecasts, although, like them, it does show moderate growth for the year.”
“the expected chance of the economy being in a recession next June rises to 12.4 percent, up from May's 9.9 percent and April's 7.1 percent, despite the slight rise in the spread. Recent data has shifted the predicted value upward, though it still remains low.”
So, very slow growth, but no double dip. Of course, this is all assuming the recession actually ended which I think is absolute nonsense. This is and remains a consumer driven balance sheet recession. The reason policymakers have failed to solve the problems on Main Street is because they have failed to properly diagnose this as a problem rooted on Main Street.
As for the predictive nature of the yield – I think we have to seriously wonder if this time isn’t different. Monetary policy has proven to be an unreliable response in the current recession. Why? Because this truly is a different kind of recession. This isn’t your typical cyclical slowdown. This is a secular systemic collapse.
Ben’s response was a sickening form of trickle down whereby he saved the banks and assumed that he could save the system from the top down. It’s the classic monetarist gaffe of trying to sell more apples by stocking the shelves with even more apples. Of course, banks are never reserve constrained which is why, in large part, saving the banks was a failed strategy from the very beginning.
For now, I am more inclined to agree with the Paul Krugman’s of the world – that the risks lie to the downside. The only thing the yield curve is predicting for now is that deflation is retaking its grip on global markets. If we let it sink its teeth into us we risk not only a double dip, but perhaps something worse. Unfortunately, policymakers and Central Bankers are uncomfortable playing the role of risk manager. They prefer the scientific method which has failed them time and time again. This it appears, is not different this time.
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Nice work TPC. I agree with you that the recession never really ended since growth was artificial.
NBER is still sitting on the fence as to when the most recent one actually ended. As Rosenberg pointed out, the last thing NBER wants is to call for an end, only to see them eat humble pie as a “new” one emerges.
If we make the assumption that this is one big recession, then the inverted yield curve from 2006 called it right.
I remember that inversion vividly. It was Christmas of 2006, I was in San Francisco and I was having a conversation the second it inverted – “recession on the horizon”. The equity markets rallied that day of course and for most of the next year.
One fact stood out to me with regards to curve inversions – they had ALWAYS preceded profit recessions. Over the course of 2007 I remember seeing the earnings picture deteriorate across every industry. First housing stocks, then banks, then retail, etc.
I wish my outlook of the future was as clear now as it was then….In the forecasting world that was like shooting fish in a barrel.
NBER is still sitting on the fence as to when the most recent one actually ended.
They always do. If memory serves, they waited about a year after the fact to call the end date of the last recession.
My guess is that they’ll eventually state that it ended during Q4 2009 or Q1 2010, and that they’ll take their sweet time to get around to doing it. GDP growth rates turned positive in Q3 2009 and thus far, unemployment peaked in Q4, and I would guess that those will be some of the primary drivers that will be used to choose a date.
curve forecast is well taken in here this morning,……….
fish might still be in the barrel, but the water sure has gotten murkier…..
was hoping you’d get a chance yesterday to comment on IB’s comment on what will shock be:
In Banking The shock will be less of a shock simply due to its simplicity. It will be the form of debt arbitrage (at least at the beginning) and will take probably 1 yr or less from the day they make the decision to let it happen. The Fed will simply stop paying interest on federal bank deposits, forcing banks to issue commercial and retail loans at much lower rates in order to have a fixed return that they're currently receiving. In order to prevent runaway inflation (as there will certainly be a rush to take out loans well below mortgage rates), I imagine the Fed will put a "sunset" clause on this move, or simply state that it will be a "pilot program" to see if it opens up the lending floodgate.
Expect this to happen in the near future. If not an outright move, it will be suggested very soon. When it is, I suggest getting heavily long because you'll likely see at least one +1000 pt DOW day (+100 pt S&P).
Great work as always
I am actually shorting 5 Year US Gov Futures (ZF) for a short term play
Good post. Excellent leading indicator historically.
I’ve racked my brain thinking about its usefulness this time around.
I don’t want to say this time is different, but I tend to agree that its utility may be less relevant now than in times past given the relative impotence of monetary policy in dealing with the situation we face.
As it stands, yield curve inversion was always used to highlight the potential for slowing economic activity vis-a-vis the risk/reward decisions banks faced in a typical lending environment. To the extent that environment actually is different this time (banks not acting as true profit maximizers and are far less focused on the reward side of the equation), suggests the yield curve is of less value.
One thing I haven’t done, but would like to do, is look at historical yield curve inversion on Japanese gov’t debt. Was it a reliable indicator when the curve was steep? How reliable was it as the curve flattened over the past 20 years as they went through a similar deflationary / de-leveraging process. Could hold the answer.
Yields have fallen to unheard of levels.
To clarify, the 10 year treasury fell to about 2.07% in December 2008, and remained at or below 3% through April of the following year. The current rate is low — probably too low — but not completely unprecedented.
TPC – you’ve said that the Euro currency system is fundamentally different from the others around the globe "“ specifically in Japan, UK and USA. Please let me know if there is any reason for budget cuts in UK – couldn’t they simply press a button, to generate pounds? Same for the US right? If button pressing is what’s coming up, why are you positioned for deflation (all cash)?
http://www.independent.co.uk/news/uk/politics/alarm-as-ministers-told-to-prepare-to-slash-their-budgets-by-40-per-cent-2018391.html
They can print Euro also. But only the ECB can do so. It can’t be done at the govt level. There is no need for budget cuts in the UK. We are not seeing high inflation and there is no solvency risk – same in the USA.
I don’t see us printing more money. I don’t think the politicians will pass another stimulus bill. They can’t even pass another unemployment extension. There’s no chance they will pass a substantial stimulus bill. As for QE (or what everyone likes to refer to as “money printing” – it’s the great non-event. It’s an asset swap that is not inflationary at all. QE is a useless strategy that bolsters bank balance sheets and does little else. It has almost no impact on the real economy.
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Much has been made about the recent action in the bond market. Yields have fallen to unheard of levels. The inflationistas and curve steepener traders are bewildered. It’s clear that bond investors are expecting very low inflation in the coming decade, but some fear it is portending far worse. Famed bond guru Bill Gross is worried about the action in the bond markets – so much so that he says the current environment is pricing in a depression. The Cleveland Fed recently released a note on the predictive nature of the yield curve. Their conclusions – a slowdown is on the horizon, but no double dip will follow:
“Since last month, the three-month rate has dropped to 0.09 percent (for the week ending June 18) from May's 0.17, and this also comes in below April's 0.16 percent. The ten-year rate dropped to 3.26 percent from May's 3.33 percent, also down from April's 3.85 percent. The slope increased a mere 1 basis point to 317 basis points, up from May's 316 basis points, but still below April's 369 basis points.”
“Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.00 percent rate over the next year, just up from May's prediction of 0.98 percent. Although the time horizons do not match exactly, this comes in on the more pessimistic side of other forecasts, although, like them, it does show moderate growth for the year.”
“the expected chance of the economy being in a recession next June rises to 12.4 percent, up from May's 9.9 percent and April's 7.1 percent, despite the slight rise in the spread. Recent data has shifted the predicted value upward, though it still remains low.”
So, very slow growth, but no double dip. Of course, this is all assuming the recession actually ended which I think is absolute nonsense. This is and remains a consumer driven balance sheet recession. The reason policymakers have failed to solve the problems on Main Street is because they have failed to properly diagnose this as a problem rooted on Main Street.
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