10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity

https://fred.stlouisfed.org/series/T10Y3M

68 45 7 years ago

fred.stlouisfed.org

bradleyjg2• 7 years ago

Given that every reliable trading signal inevitably gets arb’ed away why does everyone and his brother think this one must be rock solid?

tntn• 7 years ago

There's no better way to get a recession than to have everyone acting like there is going to be a recession. Yield inversion indicates the market is starting to think there is going to be one.

vasilipupkin• 7 years ago

This isn’t a trading signal, so you can’t arb it away.

panarky2• 7 years ago

Short-term trading signals are frequently arb'ed away.

But long-term structural patterns take far more capital to arbitrage and your position can be deep under water for years at a time.

There just isn't that much patient capital.

nickles12• 7 years ago

Short-term trading signals are systematically arb'ed away

This isn't necessarily true. There are demonstrable, persistent calendar effects that can be reliably traded. Such trading can be thought of as a service being provided to market participants for a fee (e.g. balance sheet as a service).

nickles12• 7 years ago

This signal is typically only indicative in the United States, as the Fed doesn't officially factor it into the decision making process. Other central banks consider it, so it does not seem to have the same predictive power.

The treasury market reflects demand for 'risk-free' securities, which functionally serve as bank accounts for corporate entities without access to bank reserves on the Fed's balance sheet. When market participants expect rate cuts in the future, long term assets with a locked in yield become more attractive to hold relative to short tenors, as the short dated treasuries need to be rolled more frequently.

Additionally, it may be that the curve inversion itself causes greater expense in short term funding (e.g. overnight), leading to potential contractions in economic activity.

inflatableDodo2• 7 years ago

Someone please correct me if I have misunderstood anything here, but having a better rate for a bond that matures after 3 months, than for one that matures after 10 years, is definitely a bit odd.

jerrybee• 7 years ago

It’s not odd if you think that interest rates will go down in the future. If you believe that then you should buy longer term bonds to lock in the higher rate now.

nickles12• 7 years ago

If you purchase a 3m treasury bill, you will have to roll your capital into another in 3 months. If you expect the Fed to cut rates in the interim, you will receive a lower yield on that bill. The discount on the bill helps compensate for that risk.

lordnacho• 7 years ago

Ex quant trader here.

There's no arbitrage in the strict sense, that's clear.

But there's none in the statistical sense, either. Yield curve inversion doesn't happen all that often, how are you going to confidently bet that what happened the last few times will happen again this time, given that n is so low and there's always the issue of regime change?

bradleyjg2• 7 years ago

Yes, that’s exactly why pundits shouldn’t be so confident. All the same reasons for uncertainty apply to investors and pundits alike—-but confidence in punditry garners little risk.

yasp• 7 years ago

Isn't it the 10Y-2Y which is the famous recession signal?

nickles12• 7 years ago

No, 3m-10Y is the best recession signal for the United States.

[0] https://www.frbsf.org/economic-research/publications/economi...

ianai3• 7 years ago

They’re graphing 10y-3mo here. Is that what you mean? Minus is not commutative.

asmithmd12• 7 years ago

The 10y-3m has been 1:1 preceding the last 3 recessions by about a year:

https://fred.stlouisfed.org/graph/?g=o3LQ

tyrust2• 7 years ago

Without any sort of annotation or explanation this post isn't really valuable.

That said, with annotation and explanation it would only be incrementally more valuable. TA is like reading tea leaves.

FabHK5• 7 years ago

This is not technical analysis, this is a macroeconomic indicator. No voodoo here.

tyrust2• 7 years ago

Call it what you want, it's still people trying to make predictions based on limited signal. As the top comment says, this alone isn't necessarily meaningful.

cs7024• 7 years ago

For context, this has happened before, prior to recessions, as shown here: https://fred.stlouisfed.org/graph/?g=mtiz

However, this is the first time this kind of yield inversion has occurred right after the Fed announced plans to stop reducing its balance sheet, which grew to unprecedented levels in response to the financial crisis. You can see the enormous impact that the Fed's balance sheet growth had on the monetary base here: https://fred.stlouisfed.org/graph/?g=lIdk

Until recently, the Fed had been reducing its balance sheet by up to $54B/month; it announced plans to stop.[a][b] How and to what degree has this impacted yields?

As additional context, consider that the yield inversion has occurred during a rise in import tariffs, trading restrictions, and public threats between the US and China (and now Mexico too). So far, the economic impact of these trading spats on the US economy has been small.[c] Could the recent yield inversion be caused more by a global flight to safety. in conjunction to the Fed's actions, than the actual risk of a US recession?

Is it even possible to answer these questions with certainty? I'd be leery of any predictions for the US economy based solely on this recent inversion of the yield curve.

[a] https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

[b] https://www.reuters.com/article/us-usa-fed-balancesheet/fed-...

[c] https://www.nytimes.com/2019/05/07/us/politics/trump-tariff-...

nickles12• 7 years ago

How and to what degree has this impacted yields? Is it even possible to answer this question with certainty?

To reduce its balance sheet, the Fed has rolled down assets, allowing them to mature. By choosing to not reinvest the principal from these matured assets, they reduce the size of the balance sheet. My understanding is that the reinvestment occurs in longer dated securities, which would put flattening pressure on the curve. Estimates indicate a reduction of these purchases would raise 10y yields 40-60bps [0]. All other things being equal, this would lead to steepening of the yield curve.

I'd be leery of any predictions of recession in the US based solely on yield inversion.

Not all yield curve inversions have preceded recessions, but almost all recent recessions have been preceded by yield curve inversions. Yield curve inversions lasting 10 days or longer tend to have more predictive power. The inversion in March did not last that long, for example. On average, a recession follows 14 months after an inversion [1].

[0] https://www.ft.com/content/828169e8-8902-3d5a-903d-586bf22cc...

[1] https://www.advisorperspectives.com/articles/2019/04/01/a-hi...

cs7024• 7 years ago

They recently announced they would stop doing that.

How has that affected expectations and behaviors?

ianai3• 7 years ago

It’s dangerous to reason about this without a white board, but I think that means the negative difference between 10y and 3 mo would be decreased by the fed not reinventing in long term securities.

asmithmd12• 7 years ago

It looks like a 10Y-3M inversion has predicted each of the last 3 recessions by about a year with no false positives in the last 35 year.

https://fred.stlouisfed.org/graph/?g=o4ro

Of course maybe this time is different...

panarky2• 7 years ago

Usually when the economy heats up, the Federal Reserve raises interest rates to cool it down.

Then in a recession, the Fed reduces rates to heat it up.

Historically, interest rates drop 5 percentage points in recessions.

But since rates are currently just north of 2 percent, there's no room to maneuver. If a recession hits now, the Fed cannot drop rates 5 percentage points. They'll run out of ammunition at the zero lower bound.

nickles12• 7 years ago

But since rates are currently just north of 2 percent, there's no room to maneuver. If a recession hits now, the Fed cannot drop rates 5 percentage points. They'll run out of ammunition at the zero lower bound.

There's no reason rates cannot go negative. Bund yields (Germany) are negative currently [0]. As a matter of policy, there are other approaches that may be taken. A modified Taylor rule with a zero lower bound may deliver optimal policy if the neutral rate falls below zero [1].

[0] https://www.bloomberg.com/markets/rates-bonds/government-bon...

[1] https://www.albany.edu/~bd892/Papers/TaylorRule.pdf

nostromo• 7 years ago

They'll run out of ammunition at the zero lower bound.

QE showed that the Fed has more options than lowering interest rates.

10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity

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