Yield Curves Invert in U.S., U.K
I find the general interest of the public in inversions - similar to their interest in negative yields - a bit surprising. I suppose it must be due to these concepts seeming counter-intuitive. Some brief notes, not all of which are meant to tie seamlessly together:<p>1. What&#x27;s the lag time? Inversions in the past have had rather large lag times before recessions actually began (most recently they&#x27;ve been 24 months, 13 months, and 19 months for 2s10s). Inverted yield curves signal anticipation of future rate cuts or long-term rates staying the same or whatever (depends on the shape, obviously), but if you&#x27;re of the view that global yields are just going to stay low for the foreseeable future (an increasingly common view, I make no claim as to my agreement with it) then sure the US and UK need to adjust down and get flatter. Why is there not a recognition of a new normal going on here? It&#x27;s not like money is outrageously expensive or developed economies have been running hot (as historically inversions have indicated). We&#x27;ve had a decade of reasonably good growth in the US and UK with very low rates and the assumption was that long-term rates would be ~3-4%. Maybe money will just always be relatively cheaper now with long-term targets around 2-3%.<p>2. How expensive is money? In the past when inversions have occurred the Fed Funds rate has been significantly above inflation (sometimes by hundreds of bps), making money outright expensive. Money right now is relatively expensive (compared to the past 10 years, post GFC), but historically we&#x27;re still talking about money being very cheap. I&#x27;m a bit of a relativist, but I think you need to make a distinction between money that is outright expensive and money that isn&#x27;t (as is currently the case).<p>3. Where&#x27;s high yield going? Over the past month a bit up. But this is after we&#x27;ve seem high yield spreads compress in to historically tight levels. Cov-Lite offerings are still being printed and snatched up despite the inversion of 3ms10s we&#x27;ve seen for a few months now.<p>4. Is there an issue in our financial systems plumbing? In my view, yes. The yield curve has been inverted for foreign-buyers (over 2016-2018 a very important buyer of treasuries) because they don&#x27;t fund around the 3m point, but rather on (OIS + Libor-OIS spread + XCCY of the relevant currency). If you&#x27;re a Japanese life insurer or European pension fund you can&#x27;t take FX risk (FX markets are volatile!) so you need to swap back into your local currency.<p>These hedging costs got to a point last October where you&#x27;re facing significantly negative yields (practically speaking) for foreign buyers so they buy their local negative yielding debt instead (as it&#x27;s a relatively better investment). Because US auctions can&#x27;t fail - primary dealers need to act as a back stop - you&#x27;ve had firms like JPM and BofA taking on huge amounts of treasuries. This has really clogged the o&#x2F;n repo market and is beginning to distort bank balance sheets. They can&#x27;t keep absorbing the amount of issuance the Treasury is pumping out with these trillion-dollar deficits. There&#x27;s also an issue of bill-issuance notional amounts and banks trying to elongate their duration which is dampening down the 10yr.<p>The Fed needs to cut rates further - in my view - to steepen out the yield curve to get foreign buyers coming back in. It&#x27;ll probably need to be at least 75-100bps from here to get meaningful purchases. The Fed has really pushed themselves into a tight spot from a pluming perspective.<p>5. Yields down, prices up. If you bought the 100yr Austrian bond you&#x27;d get negative yields, yes. Also if you bought the bond a few years ago you would have outperformed equities on an absolute basis. So, like, negative yields aren&#x27;t great, but asset appreciation from a sovereign bond with no default risk going into more negative territory is good if you&#x27;re a fast money player (the bond price is nearly $200 now!). In fact, it&#x27;s even good for a pension fund who has no intention of holding to maturity.