Yield Curve Inverts; Gold Awaits
Summary
- It appears that the 10yr-2yr yield curve is seeing to some unfinished flattening business from the pre-pandemic period.
- After inverting deeper than the 2019 inversion, a "steepener" will eventually follow. Inversion is not a cause to worry, but a subsequent steepening would be.
- A curve steepener can be inflationary or deflationary. Don't bet on the next steepener being inflationary (as the 2021 steepener was, and as inflation makes all the headlines today).
Melpomenem/iStock via Getty Images
Yield curve inverts deeper than August, 2019
Like the larger media, this tiny little spec within the media reports the news to you. The 10yr-2yr yield curve has inverted (ref. Yield Curve inversion upcoming). Now, what does it mean?
Well, the first thing it usually means is not to panic (especially now that High Yield credit spreads are easing), but do tune out the media hype about it. This is not the inversion that tends to signal an economic bust, but, instead, the steepening that follows it. Among the important questions are how long will it remain inverted and how deep will the inversion go before the next steepener?
Here is today’s post-payrolls (+431k jobs) move as the bond market demands that the Fed get off its ample behind and get with the inflation-making nasty headlines as inflation cost-pushes across the economy while the Fed and the long end of the curve lag well behind. But the Fed is probably lagging for a reason, and one major reason could be that they see the curve, they know what comes next, and it’s not pretty.
Yield curve (cnbc.com)
From the post linked at top:
The Yield Curve inversion in 2019 was just a tick into sub-zero. Past inversions have gone deeper than that before turning up and signaling an economic bust, among other things (the 2020-2021 steepener was purely inflationary). So maybe today’s Yield Curve has some unfinished downside flattening business to see to. Now that I think about it, was that secondary dip in early 2020 going to keep diving to a deeper inversion before [the pandemic came about] and drove the economy into a flash bust (against which the Fed inflated like all get out)?
It is important to remember that a curve steepening can be driven by inflationary (ref. 2019-2021) forces or deflationary forces. In 2007-2008, for example, the steepener was driven by both. First as crude oil gained the headlines and commodities peaked, and then during the subsequent crash as the inflation trades along with most everything else (but Treasury bonds, USD and eventually, gold) got destroyed. That curve steepened under both macro backdrops.
Yield Curve (stockcharts.com)
Will the next steepening be inflationary? I would not bet on it, given that this most dynamic phase of the inflation trades has come against an impulsive flattening. As noted in a recent article on the yield curve, gold – with its utilities for capital preservation/liquidity and by far secondarily, for inflation – looks the most bullish from the standpoint of a would-be buyer in this big picture. That is regardless of its short-term direction, which is still in question.
The options for the coming steepener are, as noted in the link just above, a von Mises-style Hellflation or a deflationary liquidation of the previous inflated boom. Either of those outcomes favors gold because Hellflation (my word for Crack-up-Boom) would be economically destructive just as would be deflation (gold’s main utility is counter-cyclical, which means anti-economy).
The way markets work, however, the odds are for a typical deflationary liquidation of the boom just as an important bond indicator is probing its potential limits. At least that would be the case if what has held true for decades continues to do so.
30yr Treasury Yield (stockcharts.com)
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Comments (6)
More importantly, the market for long-term credit is very elastic while the market for short-term credit is very inelastic. As a result small changes in demand for short-term credit causes large changes in the price, i.e. the interest rate while the price of long term credit is much more stable. It is this difference in elasticity and volatility that accounts for the fact that the difference between interest rates for short term credit and long term credit peak just before a recovery and bottom-out just before a recession.In some types of credit, this spread in yields over the term of the credit, that is to say, the Yield Curve, can even invert with short term forms of credit yielding higher interest than shorter term forms. The Yield Curve for some UST securities invert just before a recession but all yield curves are at a minimum before a recession.This yield curve, and others like it, have nothing to do with inflation or deflation.[1] fred.stlouisfed.org/...
[2] www.clevelandfed.org/...
