January 2019 Yield Curve Update

Summary

• I have discussed how there is a sort of mental accounting problem with the yield curve model.
• During the past two months, the curve has become meaningfully inverted.
• Expect the 10-year yield to be below 2% by the time that process is finished.

I have discussed how there is a sort of mental accounting problem with the yield curve model. The zero-slope is treated as a constant, when, in fact, meaningful inversion happens at low yields when the 10-year yield is as much as 1% higher than the fed funds rate, and at higher yields, the inversion has to become fairly steep to become meaningful.

During the past two months, the curve has become meaningfully inverted. Here, in the Eurodollar futures market, the upward bias of the longer-term yields is clear. What is important is that forward rates in the 2 to 3-year time frame are inverted. I suspect those 2021 Eurodollar contracts will close at rates much closer to zero.

Here is the plot of the fed funds rate against the 10-year Treasury, shown with the adjusted inversion levels. From this point, a normalized yield curve is highly unlikely to develop without lowering the fed funds rate. Expect the 10-year yield to be below 2% by the time that process is finished.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[Aricool]

thanks for helping me make sense of a similar E$ curve graph that Snider just slapped at the end of his report w/o any explanation:
seekingalpha.com/...

he shows them as underwater below 3 mo LIBOR. is that effectively the same as the graph in this article which discounts the 3 month futures interest rate?

His presentation (after reading this author's explanation) seems to be more intuitive for me b/c it shows the E$ curve is inverted (below 3 mo money) up to 5 years out, which has him conclude that the short term outlook is dire.

So, in this article's E$ graph presentation is the way to come to the same conclusion that if the slope of the 3mo rate discounted E$ yield is flat or negative then that means inversion in those areas? With that interpretation then it gives me a similar, but the same result, dire economics being priced in from 2020-2023. However, JS’s graph shows it inverted from ’19 to at least ’24. Why the discrepancy? Is the author not using LIBOR like JS?

TIA!

[Kevin A. Erdmann]

We have a slightly different x-axis, so mine goes out farther into the future, but it looks to me like are curves are about the same.