Treasury Yield Curve Inverts: Negative Interest Rates Are Dangerous

Treasury Yield Curve Inverts

In the short to intermediate timelines, this is not a big problem but in the long run, the Negative Interest Rates Experiment will end badly.

Earlier this month, the Bank of England cut interest rates for the first time in seven years, from 0.5 per cent to a new record low of 0.25 per cent. Quantitative easing was also restarted, with the Bank set to purchase £60 billion of bonds with newly created money over the next six months, on top of £375 billion of QE since March 2009. Billed as a response to the UK’s ‘Brexit shock’, the Bank’s bold move has renewed speculation that the UK could soon go even further. Negative rates will be the talk of this weekend’s Jackson Hole summit, the annual pow-wow of leading central bankers.

Eight years on from the onset of the financial crisis

And, despite huge bouts of money-printing and ultra-low rates across much of the western world, the global economy remains sluggish. Searching for new ways to boost growth, some central banks have stepped ‘through the looking glass’, setting interest rates below zero.

The European Central Bank went first in 2014, followed by Denmark, Sweden, Switzerland and, earlier this year, Japan. Private-sector banks in these countries must now pay the central bank to keep their money on reserve. Investors in government bonds are similarly paying the Japanese, German and Swiss governments for the privilege of lending to them — another example of topsy-turvy economics. Full Story

Treasury Yield Curve Inverts & Negative Rates

While rate cuts usually are seen as a way to stimulate economic growth and weaken the currency, analysts at Morgan Stanley on Wednesday raised concerns that exactly the opposite would happen were the ECB to take rates even lower. Part of this is because investors already have rejigged their portfolios to account for the policy, they explained.

Here’s the bank’s thinking:

“Further moves into negative rates will have much less of an impact on the euroEURUSD, -0.0176% in our view, given that most of the portfolio adjustment is already complete. Rather, we are concerned it erodes bank profitability, creating other systemic risks,” they said in a note

“Could the most bullish ECB outcome be no rate cut?” Morgan Stanley analysts asked.

“The credit impulse has turned negative, new loan origination has slowed, and systemic stress in the financial system has risen,” the Morgan Stanley analysts said. Full Story

Forbes on an Inverted Yield Curve

Parts of the U.S. yield curve have been inverting since last November. Now, the key 10-year yield is lower than the 3-month T-bill yield. That is by any standards a deep inversion. An inverted yield curve has preceded every U.S. recession since WWII. There is no reason to assume that this time will be different.

Tom Lee, co-founder and head of research at Fundstrat, for example, thinks that this time is different because the U.S. inversion is caused by the 10-year yield falling rather than the 3-month yield rising. “We think investors are overreacting to this inversion,” he says cheerily in an interview with CNBC. The reporter points out that the recession triggered by Russia’s sovereign default and the collapse of the hedge fund Long-Term Capital Management (LTCM) in 1998 was preceded by a rapidly falling 10-year yield, but Lee is unconcerned, saying it turned out to be a “major buying opportunity” for stocks

Mohamed El-Erian at PIMCO says he is not worried about the inverted yield curve. And over at the Fed, John Williams and Randall Quarles have both argued that the yield curve’s signal is distorted by central bank interventions. They say the yield curve’s signal is not as powerful as it used to be and doesn’t need to be taken seriously. Full Story

Treasury Yield Curve Inverts; The Tactical Investor Take

Of course, this is all rubbish for the only thing that matter is identifying the trend; once you have identified the trend the rest is all noise. Right or wrong plays second fiddle when it comes to the markets; if you think otherwise, just look at Wall Street’s cemetery, it’s full of righteous people who thought they were right but died broke. A modern example is the Gold bugs, they continue to believe that Gold will soar to the moon because of central bankers running the press to the limit, but lo and behold gold topped out in 2011 and the central bankers have printed 3X more money since then. What happened, they did take time to identify the trend and they paid dearly for this. The trend is your friend, the rest is just noise

Until the trend changes, all corrections and s0-called market crashes should be viewed through a bullish lens; the stronger the deviation the better the opportunity. Moreover do not forget the most important facet of Mass psychology, when the masses panic, run out and buy; when they are ecstatic head for the hills.