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Barron's: Bond Market Indicator May Predict Next Recession

Barron's: Bond Market Indicator May Predict Next Recession

By    |   Monday, 17 July 2017 08:23 AM

Experts are keeping a close eye on a Treasury bond market indicator, which has correctly predicted the last three recessions, for signs of disaster on the economic horizon during the Trump administration.

An “inverted Treasury bond yield curve” occurs when short-term interest rates yield more than longer-term rates. The yield curve reflects the extra interest investors require to buy bonds of a longer maturity. When they demand higher payments for shorter-dated bonds than for longer-dated ones it shows that they are more concerned about nearer-term risks, Reuters explained.

“Normally, the yield curve slopes upward, since long-term interest rates are usually higher than short-term-rates,” Barron’s explained. “Accordingly, since the chart (below) measures the slope of the yield curve by subtracting the interest rate on the three-month Treasury bill from the 10-year Treasury note, the line is usually in positive territory. But when the yield curve goes flat or inverted, short rates equal or exceed long ones, and the 10-year minus the three-month is zero or a negative figure,” Barron’s explained.

A January 2010 Federal Reserve Bank of New York report explained why an inverted yield curve signals recession. Financial institutions tend to borrow on the short end and lend on the long, Barron’s explained. And when borrowing short costs as much or more than gains from lending long, this “reduces net interest margin, which in turn makes lending less profitable, leading to a contraction in the supply of credit”—and sparking a contraction in output, Barron’s reported.

“The chart’s yield-curve measure went negative in June 1989, 14 months before the official onset of the 1990-91 recession; nine months before the recession of 2001; and most recently, 16 months before the downturn of 2008-09. Since the yield curve is still positive, it seems the expansion still has breathing room,” Barron’s explained.

And while the yield curve has yet to turn inverted, it has been "flashing warning signs on the economy, pointing to a less optimistic prediction for longer-term economic growth at the same time as Federal Reserve officials are adopting a more aggressive tone on raising interest rates," Reuters recently reported.

A flattening yield curve is often interpreted as a negative economic indicator as it shows concerns about the future pace of growth and inflation, because buyers of long-dated debt would demand higher yields if they expected higher costs.

“The Fed’s optimism has no real counterpart in any of the data that we’ve seen so far,” Aaron Kohli, an interest rate strategist at BMO Capital Markets in New York, told Reuters. “The presumption of weak economic growth is fairly firmly rooted and you can see that in the long-end of the curve.“

Dallas Federal Reserve Bank President Robert Kaplan last month said that the yield curve showed the market expected sluggish growth ahead; however, New York Fed President William Dudley said that the flat yield curve reflects low overseas inflation and borrowing costs and not a weakening U.S. economy.

To be sure, one respected financial analyst recently warned CNBC that he predicts the yield curve will invert again by the end of 2017.

“An inverted yield curve will lead to market disorder as it did in 2000 and 2006,” said Michael Pento, author and the president and founder of Pento Portfolio Strategies.

“But this next recession starts with our national debt over $20 trillion dollars and the Fed's balance sheet at $4.5 trillion. Therefore, when the yield curve inverts for the third time this century, you can expect unprecedented chaos in markets and the economy to follow shortly after. This is because the yield curve will not only invert at a much lower starting point than at any other time in history but also with the Fed and Treasury's balance sheets already severely impaired,” he wrote for CNBC.

“There will be unprecedented volatility between inflation and deflation cycles in the future due to these factors. This represents a huge opportunity for those that can identify these inflection points and know where to invest. To be more specific, sell your long positions and get short once the curve inverts; and then be prepared to hedge against inflation when the Fed responds with helicopter money.”

(Newsmax wires services contributed to this report).

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Experts are keeping a close eye on a Treasury bond market indicator, which has correctly predicted the last three recessions, for signs of disaster on the economic horizon during the Trump administration.
bond, recession, inverted, yield, curve
Monday, 17 July 2017 08:23 AM
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