This is incorrect. Most recessions in the post WW2 period have been preceded by an inversion of the 3m/10y UST curve, but it did not precede a few recessions in the USA during the first half of the 20th century.
[0] http://bonddad.blogspot.com/2011/07/yield-curve-and-pre-ww2-...
To address the GP’s point, the relationship could be fabricated, but the data don’t indicate that that’s happening.
Is that interpretation correct?
the idea is that you’re evaluated on your purchasing power ten years hence, but in one case you have to liquidate your position five years in and find another position with the same risk characteristics.
And I've never heard anyone say the fed caused the 2008 recession. It's pretty much universally agreed upon it was finance blowing up.
But it's also a bit philosophical, because any causal claim implicitly invokes a counterfactual. Like, if a bus drives off a cliff, was it the fault of the cliff or the bus driver who didn't respond quickly enough in trying to steer away? To me, common sense says that sometimes it's the cliff's fault and sometimes it's the driver's fault - the difference depends on how early the driver 'should' have known.
It's just a weird use of the word caused that gives people the wrong impression a lot of the time. If I say "Fireman Rick caused that house to burn down" most people will think Fireman Rick is an arsonist and not necessarily that he didn't act swiftly and quickly to put it out. And then if you say most houses burning down were caused by firemen many people might get the wrong impression that if we got rid of the fire department less houses would burn down instead of more.
P.s. I know Milton Friedman is to blame for this terribly tortured use of the word.
Or to give it more of a HN spin: if Rick's job was to run a website, but hackers broke in and stole all the plaintext passwords, it could be construed as partially Rick's fault for negligently storing the passwords in plaintext, even though the hackers were the ones directly responsible for the hack.
In an inflation-neutral environment, one would expect the prices of manufactured goods to be trending slowly downwards. After all, producing something less expensively is exactly what economic competition leads to.
The big pool of money has been sloshing between asset classes for a while now, but it doesn’t get reflected in inflation metrics.
If the government increased interest rates until inflation was zero unemployment would be twice what it is right now. And that seems like a high cost to pay for a neutral monetary base.
https://en.wikipedia.org/wiki/Federal_funds_rate#/media/File...
Note the massive drop (stimulus) in the early 2000s. That pushed debt levels up and encouraged the crappy loans and all that. Then the rapid increase set it off. Home prices vary inversely with interest rates, so raising them rapidly cooled the market and put all that cheap debt under water.
The fed funds rate was around 4.5% in July of 2007 before the shit hit the fan. We need room to cut interest rates to spur growth when the next recession hits. 2.25% isn't a very big margin.
But the only way to a higher nominal interest rate while keeping the same real rate is too raise the inflation rate to 3 or 4%.
They may be called that, but they aren't. There are at least two risks associated with U.S. government bonds:
1. Inflation can exceed the interest rate on the bond and cause it to lose value when measured in actual purchasing power
2. Political dysfunction could cause the U.S. government to default notwithstanding its ability to print money
(To be fair, #1 is a risk associated with any bond. #2 is peculiar to U.S. government bonds.)
#2 is true, but extremely unlikely.
Risk-free basically means the lowest possible risk. Not true zero risk.
not really, with private bonds it's replaced with the risk of the company defaulting or declaring bankruptcy.
This risk is likely also going to be true for the Dollar, so bonds don't carry any more risk than USD in this regard.
> This risk is likely also going to be true for the Dollar
It can't be, because it doesn't apply to the currency, which while it is structurally created by creation of debt is not a debt the government is obligated to pay and on which it can fail and default.
> so bonds don't carry any more risk than USD in this regard
Even if there was a default risk in the dollar, bonds necessarily have more risk since they are fully exposed to every risk to the currency they are denominated in and also their own default risk, which even if the currency had such a risk would sit on top of it.
Although Brexit happened, so never say never I guess
This was not simple, nor did you explain what this means
Here is the summary from the GP.
>[An inverted yield curve] often indicates that investors think a recession is around the corner. The reason is that investors are betting that the prevailing interest rates will drop. If interest rates drop, then future bond purchases may have much lower interest rates than those bought today. It turns out you might like the idea of getting 2% interest for 10 years rather than 2.13% for 5 years and then 0.5% for the next 5 years.
He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation?
Where is that rule written? Where did those particular numbers come from?
> He didn't address what it means for the economy. What happened last time the yield curve inverted? The last 10 times? The headline implies recession by referencing 2007, is there a valid statistical correlation?
You want the answer trimmed down to 3 or 4 sentences, but you also want answers to multiple new questions. Which one would you rather have?
This is absolutely not the reason they're considered low risk. If the USG tried to repay its debts by printing money, debtholders uninsured against inflation would lose tons of money. The expectation that they're _not_ going to print money to repay debt is part of why it's so safe.
No, they'd lose anticipated value of the debt repayment compared to other goods and services if the gov did that without other compensatory policy, but get all the money they expected.
> The expectation that they're _not_ going to print money to repay debt is part of why it's so safe.
You are confusing “why dollars are safe” with “why US government debt is safe”.
The expectation that the money supply will be managed, in total, for stability and reasonably low inflation is why dollars are safe. (The expectation of not monetizing the debt, to the extent it is relevant at all, is relevant here.)
The expectation that the US government will not in any case default is why, among dollar-denominated instruments, US government debt is considered almost as safe as actual dollars.
No, I'm correctly characterizing inflation risk, which—by definition—does not involve losing money you had or anticipated.
> You can't just wish it away by saying it's "why dollars are safe".
No, the perceived lack of significant actual inflation risk is why dollars are considered safe, not the risk category itself.
The market bids on these bonds, and the market price is public information. Let's say that people are paying $90 for a 5 year bond, meaning they pay $90 today and get $100 in 5 years. Knowing this, we can work out that this is equivalent to a yearly interest rate of 2.13%.
Now we expect that the computed interest rate for the 10 year bond should be higher than the 5 year bond. People want to be compensated for locking up their money for longer. So let's also say people are paying $80 for a 10 year bond, which works out to an interest rate of 2.26%.
These numbers fluctuate up and down every day, and they generally rise and fall with the prevailing interest rates. Here's the key question - what happens if the 10 year interest rate falls below the 5 year rate?
There are a lot of possible reasons, but this often indicates that investors think a recession is around the corner. The reason is that investors are betting that the prevailing interest rates will drop. If interest rates drop, then future bond purchases may have much lower interest rates than those bought today. It turns out you might like the idea of getting 2% interest for 10 years rather than 2.13% for 5 years and then 0.5% for the next 5 years.