...Objectivity should lead to questions about why the yield curve inverted, because an inversion caused by rising front-end rates is very different economically to one driven by falling back-end rates.
The key difference is in the price of money. Recent inversions have been driven by front-end rates rising as the Federal Reserve rapidly tightened monetary policy to fight inflation and counter policy that might have been too stimulative for too long. This caused front-end rates to rise well above inflation, making money expensive...so a large premium in excess of inflation means money is expensive. In historic inversions, money became very expensive, which naturally caused a drop in economic activity. We can call this a bear inversion.
But this time around, rather than an aggressive Fed raising rates to curtail inflation — as prices appear to be in check — the inversion has been caused by the return of a dovish and accommodative central bank, which has pushed yields down across the curve, with those on longer-dated bonds dropping more. You could term this a bull inversion.
...Today, the yield on three-month Treasury bills is just 30 basis points above core inflation. By contrast, prior to every recession since 1960 the three-month yield exceeded inflation by almost 200 basis points.
... It might be prudent to look at other markets as a more reliable barometer of economic health.
Credit curves, for example, tell a very different story. The difference in the credit spread between short- and long-dated U.S. corporate bonds is around 120 basis points, well above its average of 80 basis points since 2000.
...Nor are equity markets signaling imminent recession. On the contrary, they are forecasting growth. The upside implied by calls versus the downside implied by puts on the S&P 500 Index are trading near average levels,
To contact the authors of this story:
No comments:
Post a Comment