Wednesday, September 4, 2019

Inverted Yield Curves, Russian Collusion: What Next?

30-year bond yields at historic lows
Liberal cable news outlets that desperately want to get President Donald Trump removed from office any way possible have seized on the “inverted yield curve” as the next best political way to get him out of the White House.
Why use a financial term in electoral politics?
“Russian collusion” didn’t work. Impeachment is a moot point since the 2020 election is already underway. Why not jump on “inverted yield curves” to scare voters to vote against him even if hardly any know what it is?
Put very simply, an inverted yield curve happens in U.S. Treasury bond markets when long-term rates in 30-year bonds are lower than short-term rates of, say, 2-year bonds. When investors get spooked by something negative they see in economic indicators, they want to put their money in the safest possible financial instrument they can find.
When investors bid up the price of the 30-year bond for its safety, the effective stated yield on any issued bond is essentially pushed down. Such a flight to safety usually diminishes the demand for short-term bonds, which then drop in price by comparison and drives their effective interest rates up.
Short-term interest rates going up are not good for the economy either. Higher interest rates mean it costs more for businesses to borrow and invest, hurting their expansion plans or need to hire more workers — although one has to wonder how much of difference it really makes when we are in the lowest overall interest rate environment since the 1960s.
Many economists see inverted yield curves as harbingers of a recession occurring anywhere from 8 to 24 months after inversion.
In the hopeful eyes of MSNBC and CNN commentators, a bad recession will happen right when people go to the polls to vote for President Trump or Elizabeth Warren perhaps in November 2020.
Is it a “definite” indicator of a looming recession?
Ed Yardeni, a noted investment strategist, wrote in a recent newsletter that “an inverted yield curve has predicted 10 of the last 7 recessions.” He went on to say: “Inverted yield curves don’t predict recessions … They’ve tended to predict financial crises, which morphed into economy-wide credit crunches and recessions.”
There have been at least two occasions since 1960 when an inverted yield curve flashed an incorrect prediction for recession, in 1965 and 1998.
If this is a false reading of the inverted yield curve with no financial crisis in the offing, what else could be going on?
Apparently, the whole world is sending money for safekeeping in the U.S. Negative interest rates in Europe will do that to nervous investors as will unrest and tension in the Middle East, Hong Kong and China.
Inverted yield curves might not mean what they used to mean. In 1980, the yield on a 30-year bond was near 15%. In 1990, it was 9%. In times of higher interest rates, inverted yield curves meant more than they do in the flat 2% interest rate, essentially zero inflationary expectations of today.
A real estate investment executive said their investment projects were slowing down some, but not because he thinks a financial bubble-induced recession is imminent. Cost of materials is rising as are the costs of labor due to a shortage of skilled construction workers, but the main thing constricting their new investments is competition from foreign money looking for a safe harbor in America.
His investors typically have demanded 8% returns on their investments. He turned down a recent investment from a Lebanese investor who wanted only a 5% return, an amount that would undercut his longer-term partners which he was unwilling to do.
For now, America is looking like the only place where sophisticated investors the world over are paraphrasing a quote oft-attributed to Will Rogers: “I am more concerned with the return of my money than the return on my money”.
Relying on inverted yield curves as a political tool to get President Trump out of the White House might not work any better than “Russian collusion” did.

(first published in North State Journal 9/4/19)

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