Yield Curve Inversion

2022年8月8日

The chart above is a yearly chart of the ratio of the 10-year Treasury yield (US10Y) to the 2-year Treasury yield (US02Y). The chart is meant to highlight how extreme the yield curve inversion is getting. Typically a yield curve inversion is indicative of an impending recession.

Usually, the 10-year treasury should have a higher yield than the 2-year treasury since there is more risk involved when you invest in a longer-term treasury. Just recently, the 10-year treasury yield has reached a record low ratio of only about 85% of the 2-year treasury yield. In other words, investors are being compensated less for taking more risk.

As the chart below shows, the rate of change (on a quarterly basis) in the 2-year Treasury yield has been parabolic.



Below is the rate of change (on a quarterly basis) in the 10-year treasury which is typically more stable than the rate of change seen in shorter-term treasuries. The chart shows that the 10-year treasury yields have also been moving up at an unprecedented quarterly rate of change.



Many analysts look to an inversion of the 10-year yield with the 3-month yield, which has not yet occurred. The failure of the 10-year yield to invert relative to the 3-month yield is likely due to the unprecedented rate of change in the 10-year yield, which has historically remained relatively stable. If the 10-year yield is moving up at a higher rate of change than the 3-month yield, this can delay or prevent an inversion altogether.

Check out my analysis from July for a more in-depth discussion on why the failure (or delay) of the 10-year yield to invert to the 3-month yield might be signaling that we've entered into a new supercycle, in which higher yields may continue for the long term:

2023年3月1日

ノート

It's hard to believe that I posted about this yield curve inversion over a half-year ago and that it still continues to worsen.



The yield curve inversion is a reliable predictor of a recession. It reflects that monetary conditions are tightening. By design, monetary tightening typically results in some degree of economic slowdown. So it's quite likely that there will be a recession due to the Fed's extreme monetary tightening.

However, an interesting anomaly is occurring. The current yield curve inversion is reaching unprecedented extremes and inflation is not abating to the extent necessary to allow the central bank to pivot to easier conditions. This is extremely worrisome because it signals that even if the central bank induces an economic slowdown (recession) by tightening monetary conditions, it may not fully mitigate inflation. I've explained in other posts that this is because scarcities are persisting even as demand cools. This results in stagflation.

In my post about the coming period of stagflation (linked below), I explain how I reached the hypothesis that, in the years to come, Treasury bond yields may rise much more than many market participants currently expect. I reached this hypothesis by analyzing momentum on the yearly chart alongside a log-linear regression channel applied to a ratio chart of stock prices and Treasury bond prices.

In another post, I explained that the Fed Funds rate is driven by the market and that we can extrapolate that higher rates are coming just by looking at futures contracts. Although many futures contracts can give insight into the Fed Funds rate, in the post below I explain how we can extrapolate rates just by looking at E-mini S&P 500 futures contracts.

High inflation undermines the integrity of fiat currency, including the U.S. dollar. One primary function of a currency is to act as a store of value. The higher inflation goes, the less valuable each dollar becomes, and the less able it is to fulfill its goal of storing value. Eventually, when inflation reaches a certain tipping point the public begins to question the value of the fiat currency altogether, and the public begins to seek to store value in other assets.

It remains unclear whether market participants will primarily embrace precious metals including, of course, gold, or if they will turn more so to Bitcoin and cryptocurrency. I think that the market will drive up the prices of both, but in the long run, Bitcoin and certain cryptocurrencies will win.

Cryptocurrencies offer everything gold does except more efficiently, with the sole exception of tangibility. However, in an increasingly digital world, the lines between physical reality and digital reality will begin to blur in ways that will erode gold's tangibility benefit, leaving Bitcoin and certain other cryptocurrencies, at an unrivaled advantage. In some ways, the blockchain and cryptocurrency actually represent the next step in the evolution of financial markets and human transactions.

Whatever economic storm arises from this extreme yield curve inversion, it's likely to be accompanied by extreme volatility. So, in this respect, all asset classes are vulnerable to declines for as long as the yield curve is inverted.

At the very first sign of a liquidity crisis, the Fed will quickly unwind its overnight reverse repurchase agreements. So a great chart to keep an eye on for an early indication of trouble is: RRPONTTLD. If you see this suddenly plummet, the crisis has likely begun.