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Minyan Mailbag - Look at those Curves!


It's a communications breakdown alright.


Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Hi John - That the yield curve has been useful in ascertaining the economic future is not surprising in that there are identifiable fundamentals at work.

The fed can "arbitrarily" set short-term interest rates, and historically has often erred as to the appropriate extent and timing of short-term interest rate adjustments.

B. The markets have historically controlled longer rates. The market has a vastly superior record for accuracy than the fed.

So, an inverted yield curve has been a valuable indicator in that the more prescient market sees economic weakness, while the fed has not appropriately set short-term rates for the market-assessed extent of future economic weakness.

This time, however, it's not so clear-cut. There is reason to suspect that the rates normally set solely by market forces are being "manipulated" via foreign and fed intervention; including monetization. (I believe that is the case, and that the long end of the curve would be 1.75% - 2% higher TODAY with "market" set rates.)

Secondly, and more subjective in the equation, is calculating a future interest rate risk that the market is not pricing in. It is in this arena where I am of the "opinion" that the market has not grasped the extent of the complex bubbling future inflation potential. As a consequence, my assumption is that risk is also skewed toward higher longer-term interest rates to a greater degree than what market forces currently "would" factor, (if left to their own volitions).

Bottom line: If you believe that market forces are efficiently pricing the bond market, then you should expect extensive economic weakness plus low inflation or the potential for disinflation.

If you believe as I do that market forces are at least temporarily being subverted by other forces, then the flat & moving-towards-inverted nature of the yield curve is not communicating in its usual clear fashion, and in fact would not exist with truly free-market set rates.


Minyan Jeff

Jeff - Agreed. In addition, it is the short end that is manipulated through central banks which then lowers the long yield. The short end manipulation ending could result in inversion.


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