Published: Fri, December 07, 2018
Markets | By Otis Pena

What A Yield Curve Inversion Means For Traders

What A Yield Curve Inversion Means For Traders

Germany's 10-year bond yield fell to its lowest in four and a half months at 0.265 percent and was last down 4 bps on the day. Most of the time, banks demand higher interest for longer periods of time (cuz who knows when they're gonna see that money again?!).

That boosts the cost of borrowing for American households, and in turn pushes short-term Treasury bill rates higher, while putting downward pressure on long-term rates.

"There is a good reason why an inverted yield curve shows us a potential recession: it means credit is very tight, and expectations for growth and inflation are reduced", said Kathy Jones, chief of fixed income investments at Charles Schwab.

That tipping point has preceded most United States recessions since 1950, and the curve last inverted in February 2006 prior to the 2008 recession.

The MSCI's all-country index shed 0.5 percent.

German 10-year yields are also being pushed down by domestic concerns, Commerzbank's Rieger said, with European growth indicators sagging and Italian political concerns rumbling on in the background. It's hard to say - but we prefer this explanation: Since December 2015, the Fed has implemented a series of 6 interest rate hikes and simultaneously cut its balance sheet by $50B a month.

"I do continue to expect that further gradual increases in interest rates will best foster a sustained economic expansion", Williams said at the New York Fed.

The bond market is flashing warning signs after the U.S. Treasury curve inverted for the first time in more than a decade.

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That message, of a Fed committed to a strategy that would not be shaped by short-term data, was echoed this week by Fed vice chair Randal Quarles.

"The U.S. economy is likely to be able to withstand another rate hike or two, therefore, the flattening of the Treasury curve looks a little over done".

Even as the announcement of a "truce" in U.S. USA financial shares, which are particularly sensitive to bond market swings, dropped 4.4 percent.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either. "Keep it simple. Quantitative Tightening is bad for stocks".

The yield curve is now at its flattest level since before the past recession in view of more dovish comments from the Federal Reserve.

But since then, it has persistently declined, especially since the middle of last week, and now is at its narrowest since July 2007, on the eve of a steep recession.

German 10-year yields slipped to six-month lows of 0.247 percent before rising back to 0.259 percent. The Big One will be when 2-year and 10-year Treasury rates swap places, and bond traders are doing their darnedest to make it happen soon, as Robert Burgess points out.

"What sounds good at the dinner table becomes rather hard at the negotiating table - the market now knows how to read Trump, he knows how to create big news at bilateral meetings but then when it comes to the nitty gritty it can be a very different story", he said.

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