More August Face-Plants. This Time with an Inverted Yield Curve

Whew! This August is starting to smell a lot like last December, if you know what I mean. The market is trying to commit hari-kari. But some of us are wondering why.

The latest reason for markets to reach for a suicide weapon is the dreaded “inverted yield curve.”

Let me try to explain the term for those who have been following news of this Martian landing since yesterday morning.

The yield curve is a simply depiction of interest rates from current to longer dated. The curve normally has an upward slope to it. Makes sense, since the risk of not getting your money back is larger the longer it is out of your hands. Think about a CD.  Should you get more interest for a one-year CD or for a five-year CD? A five-year, for sure.

Yesterday morning, the two-year US Treasury Note, for about two hours, paid more interest than the ten-year Treasury Bond.  History shows when this happens – and it happens infrequently – it is a harbinger of a recession a year of two in the future. And, for sure, recessions kill stock markets.  So we don’t want recessions, and we don’t want inversions of the yield curve.

But every inversion does not, and has not, given rise to a recession.  But investors still worry at the first sign of a yield curve inversion.

So, should we be worried?  Short answer from me: No.

Here’s why. Typical inversions occur with a number of things going on.  Current interest rates are rising because the Federal Reserve is RAISING interest rates to slow down a hot economy, and long-term rates are falling because investors see that the rising short-term rates are going to hurt the economy.

That’s not what’s going on today.  Today, current rates are very low and probably going lower. But ten-years bonds are about as low, if not lower, because an incredible $15 trillion of government bonds throughout the developed world are paying NEGATIVE interest rates. (Negative interest rates were unheard of until a few years ago.) Negative rates pay back people LESS money than they invested originally.

Why would anyone do this?  Because investors around the world are terrified of financial conditions in many places, and developed governments in Western Europe thought this would be a good way to force people with money to take risks or banks to lend more money. Because if you didn’t put your money in a non-interest bearing investment, then you will be punished with a negative return on your money.

Has it worked?  Not a bit.  But that doesn’t mean governments will admit defeat.  Heck no! They will try negative rates any day rather than lower taxes and reduce anti-business regulations to stimulate real economic activity.

The upshot of this mess is that massive amounts of foreign and domestic money is moving into the US government bond market. And, please know, when there is more demand for bonds (or anything else), their price rises and their interest paid falls. Hence, our ten-year Treasury bond is being driven towards the lowest rates in US history.

These are not preconditions for a recession, except for the fear that surrounds our markets.  Otherwise, America’s economy looks good – not great – but good. With low interest rates, low gas prices, plenty of jobs, and an economy that is 70% consumer-driven. It’s the hottest – maybe the warmest – economy in the world.

August will pass. Short of something more substantive than foreign money driving down our interest rates we’ll get through this.  Once again, we look at the power and the corruption of a press/media complex that is more attuned to creating fear and viewership than explaining what is really going on.

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