Tag Archives: yield curve

Heads Up: The Insiders Are Trying To Tell Us Something

Lord knows there are enough reasons to feel morally outraged and politically incensed these days — the “sordid legacy” of the Japanese Internment policy rising up in the Muslim ban decision; the continuation of the moral depravity demonstrated by the Mis-administration’s Immigration policy; the utter stupidity of trade spats and tariff wars with our friends, to name some major causes for immediate concern.  However, there’s one more, esoteric as it is, which hints at some problems yet to come — Jacob Marley’s third visitor waiting in the wings.   It’s called a yield curve.  The New York Times explains:

Terms like “yield curve” can be mind-numbing if you’re not a bond trader, but the mechanics, practical impact and psychology of it are fairly straightforward. Here’s what the fuss is all about.

The yield curve is basically the difference between interest rates on short-term United States government bonds, say, two-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.

Typically, when an economy seems in good health, the rate on the longer-term bonds will be higher than short-term ones. The extra interest is to compensate, in part, for the risk that strong economic growth could set off a broad rise in prices, known as inflation. Lately, though, long-term bond yields have been stubbornly slow to rise — which suggests traders are concerned about long-term growth — even as the economy shows plenty of vitality.

Okay, pretty straight forward so far.  Something has the traders on Wall Street spooked about long term economic growth.  So what?  Well, all those pretty predictions about what the Great Trumpian Tax Giveaway To The Rich and Richer would mean for the overall economy were based on what were already unrealistic expectations for economic growth, and now the traders are edgy about even that?  A stagnant, or worse faltering, economy could easily turn a really bad idea (and we’ve figured that out already) into something close to catastrophic.  But fear not, the Trumpers will castigate the previous administrations for causing a problem the Trumpers created for themselves; whilst the Trumpers announce They Alone Can Fix It…with something worse than the initial problem because there is never a Plan B because they never had a Plan A to begin with.

Thus the New York Times continues:

At the same time, the Federal Reserve has been raising short-term rates, so the yield curve has been “flattening.” In other words, the gap between short-term interest rates and long-term rates is shrinking.

The Times has my attention at this point, and then the old Gray Lady gets me bolt upright.

The gap between two-year and 10-year United States Treasury notes is roughly 0.34 percentage points. It was last at these levels in 2007 when the United States economy was heading into what was arguably the worst recession in almost 80 years.

Ouch.  Before we hit the Panic Button, there’s no way to predict exactly when recessionary pressures take form, and we can’t be certain that the central banks may not take actions which mitigate the recessionary trends associated with previous economic downturns.   However, we can’t ignore a situation in which people put more funds into long term investments which in turn causes more people to put ever more funds into long term investments because they fear a recession, and wishing makes it true.  And, this spiral makes banking a losing proposition — borrow at short; lend at long; hit the golf course by 3 — inversion can, as the Times says “slam the brakes on” the banking sector. Love them or hate them — banks are the circulation system of good old fashioned free market capitalism.

So, we need to keep the economic data in our peripheral vision as we stare into the abyss of corrupt immorality and utter ineptitude so evident in our current mis-administration. We can’t say the traders didn’t try to warn us.

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Very Basic Finance

There are some excellent references available on-line concerning what financial institutions trade.  And, once more I apologize for the redundancy in the basic message BUT it is important:

One mans debtIn the simplest of all realms, if I owe you $25.00 then I’m in debt and you hold something receivable; the $25.00 plus any interest we’ve agreed upon. The “bond” is a more sophisticated IOU.  The safest of these are Treasuries which come in three basic flavors — Treasury bills (13 weeks to 1 yr. investments), notes (2 to 10 yrs.), and bonds (10 yrs).  Because these are backed by the full faith and credit of the United States of America the Treasuries are the safest IOU in which a person can invest.

There’s also a gadget called a “Zero Coupon” Treasury” best explained by the CNN Money description:

“Zero-coupon bonds, also known as “strips” or “zeros,” are Treasury-based securities that are sold by brokers at a deep discount and redeemed at full face value when they mature in six months to 30 years. Although you don’t actually receive your interest until the bond matures, you must pay taxes each year on the “phantom interest” that you earn (it’s based on the bond’s market value, which usually rises steadily during the time you hold it). For that reason, they are best held in tax-deferred accounts. Because they pay no coupon, zeros can be highly volatile in price.” [CNNMoney]

And, there’s one more Treasury on the ladder, the inflation indexed Treasuries — also explained by CNN Money as follows:

“Inflation-indexed Treasuries. These pay a real rate of interest on a principal amount that rises or falls with the consumer price index. You don’t collect the inflation adjustment to your principal until the bond matures or you sell it, but you owe federal income tax on that phantom amount each year – in addition to tax on the interest you receive currently. Like zeros, inflation bonds are best held in tax-deferred accounts.”  [CNNMoney]

Notice these last two are better placed in someone’s “tax deferred” account.  In the case of all these forms of bonds, if you have them in your portfolio then you are holding government IOU’s + the interest the government promises to pay.   Want to find out those interest rates? The Department of the Treasury has a whole page for that.   Want Bells and Whistles? The Treasury site has a page for that too, with charts, historical data, and graphs.

How I Calmed Down And Learned Not To Be Scared Of The National Debt.

First, breathe deeply.  Simply because some commentator, pundit, or investor is making hissing sounds whenever the topic moves to the National Debt, doesn’t mean we have to panic.

Remember all five of the forms of Treasuries are secured by the federal government.  But, but, but… The Chinese are about to “own” us?  Yes, China tops the list of foreign investors in U.S. Treasuries, with about $1316.7 billion in their accounts.  Does that mean the Chinese “own” us? No.  Like every other domestic investor they want to (1) hold the bond to maturity and collect the interest; or (2) sell bonds in the bond market at a profit.   But, but, but… what if they cashed in all at once?  Stop.  Think.

They bought the bonds for the same reason we’d buy E Series savings bonds — because they’re an ASSET.  Government debt being our asset.  Now, what possible reason could the government of China have for dumping all its ASSETS on the market at once? Most folks cash out in circumstances which are usually on the negative side. We cash out when we need to raise funds or when we think the value of our ASSETS may decline.  So, do, governments.

As long as other countries view the United States as an economic power — which we are, with the largest economy on this planet — then investing in US is a good idea.   It’s in our own best interest to keep it that way.   As of 2014, the U.S. economy is valued at approximately $17 trillion; China at $10 trillion; Japan $5.3 trillion; Germany $3.7 trillion; France $2.8 trillion; Brazil $2.6 trillion; U.K. $2.5 trillion. [CNN

There are two reasons foreign investors like purchasing U.S. Treasuries.  The first is obvious from the list of values in the last paragraph. We’re the biggest, safest, investment they can make.  The fancy term is that we have “premium risk free assets” on the market.  Secondly,  these Treasuries are liquid.  Liquid + Safe = a very desirable investment.  There’s also a third reason, we’re the world’s reserve currency, with some 87% of all financial transactions in global foreign exchange markets taking place in U.S. dollars. [GAO]   Because we are the largest Gorilla in the Financial World, we can borrow surplus savings from other countries beyond what we could invest all by ourselves.  The GAO report phrases this more elegantly:

“…an economy open to international trade and investment, such as the United States, essentially can borrow the surplus of savings of other countries to finance more investment than U.S. national saving would permit. The flow of capital into the United States has gone into a variety of assets, including Treasury securities, corporate securities, and direct investment. [GAO]

That’s the preferred direction for investments — INTO the United States.   The bigger and safer we appear, the more surplus savings from abroad we can take in, or conversely when the economies of other countries aren’t looking too attractive the capital flows into our “safe harbor.”

There are limits, as there are to all human endeavors.  We don’t want to rack up “too much” indebtedness” such that investors start to look elsewhere and we have to raise the rates (yield) on our bonds, bills, and notes.   The trick is to determine what’s “too much.”

National debt clocks are useless.  The only thing those graphics are good for is to scare people into believing we already have too much indebtedness.   Those inclined to panic should step back from the abyss and remember that our debt is someone else’s asset.  Assets they are holding because they believe we are the best, safest, investment they can make.   How do we know that the world is still happy with us?  We look at the Yield Curve.

Where do we find that Yield Curve?  On the front page of the U.S. Treasury Department’s web site.   The U.S. Treasury is currently paying 0.04% to attract investors in one month bills; a two year note currently pays 0.30% interest; and, a 30 year bond pays 3.55%.    It’s fairly apparent when the “too much” level has been hit — the yield on a 10 yr. bond from Greece is a whopping 8.18% (compare to U.S. 2.59%.) [Bloomberg]

Thus, when the Advocates of Austerity cry, “Look at the Clock!” The correct response is “Look at the Yield Curve.”  In other words — what we really ought to be wary of is the day that the Yields soar upwards.  That “debt clock” is a gratuitous graphic, which obfuscates the real issue: If we are going into debt are we getting a return on it?

Debt incurred for war/military operations is essentially a loss on the books.  We borrow money and then blow things up.  Debt incurred for the improvement of infrastructure projects means that we may just be using other people’s surplus savings to build our own highways, air transport facilities, and communications systems, all items which become assets on our own books.   The essential question concerns the purpose to which we put those borrowed funds.  

Now, breathe more easily and decide HOW we should be spending the surplus savings we are siphoning off from foreign investors.

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