Friday, May 8, 2020

April 2020 Yield Curve Update

The Eurodollar charts are updated through today.  The Treasuries chart is monthly.

The Treasuries chart suggests that the yield curve is functionally inverted.  (The 10 year yield needs to get above the trendline.) Forward 5 year inflation expectations are below 1%.  There is a lot of focus on the targeted lending facilities, etc., but, as in 2008, the Fed could really just do more standard stimulus.  Just buy a bunch of Treasuries.  If the cash just ends up in excess reserves with no increase in forward nominal spending and inflation expectations, then buy more.

The Eurodollar curves provide a little more optimism.  It is good that in recent days, the long end of the curve has held up and lower rates are mostly from declining rates at the short end.  The Fed could do more, but it could have done less, too.

The last chart, which is the market estimate of the first rise in Eurodollar rates, suggests also that the Fed has stimulated somewhat, but could do more.  Before the coronavirus outbreak, I was worried that the Fed was just keeping monetary policy below neutral, so that the expected first date of an eventual rate increase was slowly moving back in time, similar to what had happened after 2008 each time they suspended Quantitative Easing operations.  I was looking for the expected first date of a rate increase to move back to December 2021, which would have been bearish.

I thought that the pandemic might trigger a response from the Fed that was less complacent, and actually shorten the length of a coming contraction, even if the contraction was deeper.  At first, this seemed to be the case, with the expected first date of a rate hike moving briefly all the way up to September 2020.  Since then, it has moved back to September 2021.

At this point, a lot depends on near term real shocks related to the pandemic.  But, higher inflation expectations would help, on the margin, I think.

Disclosure: I do not have a position in UBT any more.


  1. Simon Ward in his articles in argues for better growth and inflation prospects than we think, because money quantity is skyrocketing, particularily in US. I'm not able to make a judgment on it, but it resonates with my lay logic for perplexingly strong stock market: if you get boatloads of money and can't spend it on haircuts and cruises, why not buy stocks? If the money takes this sideroad of first being used to pay for an asset that does nothing in itself but store(?)...the money until the guy who sold the stock decides to buy a cruise holiday with it or a new factory production takes a longer time getting there. Maybe I'm just stupid, but maybe at some point it's the barber who comes to ask for a nice chair from the factory guy. And suddenly factory guy doesn't use his money to buy a stock, but perhaps stocks up on the stuff chairs are made of. And the guy who bought factory guy's stocks has one less buyer for his assets and must cut prices.

    Am I dumb or wrong? Because it looks like it's all about the barber to close the feedback loop and things could get rather wild. Gov bonds seem just another asset class facing a lot of buyers with nothing better to do?

    Btw Diamond Princess turned out to be a brilliant test environment if we bothered to study it even a bit. It was the main reason I was so pessimistic, but now reason for optimism. Only 700 out of 3500 got infected in a packed buffet boat with infected crew serving food to cabins and we pretty much know why: it's not the touch, but the cough. That we can stop. :)

    1. Thanks for the input. I try to shy away from these sorts of narrative approaches. It's really hard to account for everything if you try to think it through in that way. That being said, money might be going into short term fixed income securities and deposits, driving down short term interest rates, but my rule of thumb is to attribute equity values to future income expectations. To the extent that monetary policy is boosting stock prices, I think it is due to being a stabilizing factor that is preventing us from having an unnecessary deflationary shock on top of everything else, so that the recovery can happen more smoothly. I don't think people looking to hold on to a few thousand bucks for a few months are keen on buying equities that are fluctuating by 10% every week or month.

      It's hard to falsify these things, so debates will continue, but I think a lot of bad analysis floods the airwaves based on the notion that equity values are unmoored from the fundamentals and rise and fall with monetary stimulation.

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