Wednesday, September 4, 2019

August 2019 Yield Curve Update

I had a brief flirtation with optimism, but the last couple of months have seen a bearish turn. 

This first graph is a graph comparing the Fed Funds Rate and the 10 year Treasury yield.  The orange line is the effective inversion line.  The zero lower bound means that long term yields have a kind of option value, biasing the yield curve upward.  This is my attempt at adjusting for that effect.  The yield curve is highly inverted.

In the meantime, the Fed seems to be tepid about their recent dovish turn.  It would take quite an aggressive posture for them to get ahead of this.  For this to become less bearish, the 10 year yield would need to rise substantially.  It's unlikely to do that without an aggressively dovish move, which the Fed would signal with a sharp decline in the Fed Funds Rate.

I expect the long term rate to bounce around a bit, but it seems unlikely that it will push back away from inversion.

The second graph shows the yield curve at various dates over the past few months.  It has flattened even as short term rates have declined.


  1. Mark Carney, BOE, recently said long-term interest rates are set globally such as those on 10-year sovereigns.

    So the Fed really has little influence on long-term interest rates. If there is a global glut of capital, then long term rates will come down. If the supply of global savings is too large for the ways to employ savings, then people must lose money on their savings and that should be reflected by negative interest rates. It may be that kleptocracies and tax evaders also add to the pool of savings.

    This raises a fascinating issue. Suppose the natural or real equilibrium interest rate is negative? So if we move to a very low or no inflation economy then we must expect negative interest rates as The New Normal.

    This may mean that an inverted yield curve conveys less information than before.

    The real challenge will be for financial institutions, who have survived by arbitraging between long and short-term rates, to make profits on the spread. This is doubly concerning as we rely on financial institutions, that is commercial banks, for the endogenous creation of money.

    Fun note: the Swiss National Bank now has a balance sheet at about 225% of Swiss GDP. The Swiss national debt, as conventionally viewed, is at about 25% of Swiss GDP. The Swiss National Bank gorged on foreign bonds in recent years in an effort to hold the exchange rate of the Swiss franc from appreciating against the euro. In fact, the Swiss National Bank owns about $100,000 of foreign bonds for every Swiss resident. QE in Switzerland did not result in higher GDP growth however.

    But Swiss central bankers are working to make sure that the residents of Switzerland do not benefit from this bounty.

    Why not give every Swiss resident $10,000 in Swiss francs and tell them they must spend it outside Switzerland? That would tend to hold down the exchange rate for the Swiss franc.

    Previously, macroeconomist thought that negative interest rates would this spell savings. But people must save for retirement, perhaps for college education, to start a business, for unexpected calamities. There is also the example of forced favings in authoritarian states such as China and Singapore, or cultures that are savings oriented, as across the Far East.

  2. Another stray thought:

    In FY 2020, the US government will pay out nearly $500 billion in interest.

    And it will borrow about $1 trillion.

    So....did the US government really pull out of global capital markets $1 trillion...or only $500 billion?

    If the US federal budget was "balanced" would it really inject $500 billion into global capital markets?

    1. I would say the $500 billion isn't an injection of capital. It's a transfer from a taxpayer.