Inversion of bond yields

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hailoh

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Thursday, June 02, 2005 - 12:02 am:

Each week Colin comments on the spread between short and long term bond yields, noting that a fall below 1% is a long term bear indicator.

Visit the dynamic yield curve at Stockcharts.com and see how a yield inversion does coincide with a major downturn.

Alan Kohler in the SMH today noted that bond yields in Australia are inverted: that is the long bond yields are lower than cash rates- an unusual occurrence in his words. Yet, his article was extremely bullish.

Can I pose the question to Colin: does his comment on yield inversion apply in all markets? Is he (or any contributor for that matter)able to post charts of this behaviour historically for the ASX?

I am impressed by the Dow Jones evidence - hard not to be. And if the press is pushing optimism where optimism shouldn't be, isn't that a call to contrarian arms?

[Apologies Hailoh, I missed this question. I think this has been answered by my discussion of yield curves and the Wright Model. Regards, Colin 2007-05-28]

(Message edited by colin_twiggs on May 28, 2007)

hailoh

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Wednesday, March 01, 2006 - 04:29 pm:

I was wrong in referring to the Dow Jones index in the previous old post. The correlation of a recessionary sharp reversal and the development of inversion between short and long term bond yields in the US was strongest with the S&P 500. Inversion started about August 2000 and lasted until January 2001. It took about 6 weeks for the S&P to peak in mid September 2000, and thereafter it was all down hill.

S&P 500 weekly

Although the Dow and the XAO and most Australian sectors dipped a little in September 2000 the follow through was nowhere near as dramatic, except for one index- the XDJ ( Consumer Discretionary).

XDJ Weekly

The similarity between the two charts is quite striking. If yield inversion in the US does materialise,and history repeats itself, it may take 4 to 6 weeks for economic events to unroll and destabilise the market. There could be interesting grazing amongst high fliers in the Australian Consumer Discretionary sector for traders looking to go short.

fibonacci

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Wednesday, March 01, 2006 - 09:04 pm:

Very interesting hailoh,

Is 1 out of 1 enough to "prove this relationship?

Have you studied previous similar occurrences? If so did they reveal the same?

John

You've got to
know when to hold 'em
know when to fold 'em.

hailoh

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Thursday, March 02, 2006 - 05:54 am:

Good question, John. The conventional wisdom about the relationship was given a solid airing a few weeks ago when the ratio partially inverted for a day or so. I haven't found a charting/economics source that goes back further yet, though I have no doubt relevent material exists in subscriber websites offering archival material. I'll keep looking.

hailoh

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Friday, March 03, 2006 - 08:38 am:

Hi Fibonacci.

A reference from Bloomberg reported inversions at these times:

1/1/80 to 25/4/80
12/9/80 to 23/10/80
22/1/62 to 16/7/82
6/1/89 to 23/6/89
11/8/89 to 6/10/89
24/2/00 to 22/12/00

The US National Bureau of Economic Research recorded recession dates for the same period as:

January 1980 to July 1980
July 81 to November 82
July 1990 to March 1991
March 2001 to November 2001

I have plotted these on the attached chart, where the inversions are the little tents and the official recession the horizontal lines. Movements in the market tend of course to anticipate events.

S&P 500 inversions and recessions

The correlations aren't ironclad but with each recession there has been a period of inversion preceding or associated with it. It may be that the actual inversion is simply a sideshow to the main story about rising interest rates, contraction of consumer spending strength, mortgage repayment squeeze, contraction in demand etc.

It all takes time for the indicator to unfold, but there seems to be fire associated with the smoke.

fibonacci

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Friday, March 03, 2006 - 10:03 am:

Hailoh, that's great info.
Your conclusion appears valid also.
Every week Colin notes possible dire consequences for the share market in regard to inversion of rates so more facts are helpful.
I have a narrow self-interest in that all my Superannuation money is in Australian heavyweight shares and at the moment the only possible change I've got in the frame is a switch to more international shares.
BUT the correlation between inversion and share market performance looks tenuous at best as the last one is the only one of significance [in long term] and "THE BUBBLE" could well have been a more significant cause of such a violent bear market.

John

You've got to
know when to hold 'em
know when to fold 'em.

moleman

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Sunday, May 27, 2007 - 02:32 pm:

G'day

I notice Bill McLaren is saying the 24-year bull run in 30-year T-bonds is at an end. He says this will lead to interest rates going up.

http://www.mclarenreport.net.au/articles/articles/134/1/May-25-2007-mclarenrepor tnetau/Page1.html

If he's right that has to be very significant and have huge implications. Is this a sign that with the weak USD, others aren't so prepared to finance the US debt? I've only got a layman's understanding of bonds so would appreciate comments .

cheers

MM

kate

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Monday, May 28, 2007 - 09:01 am:

MM

I've just been catching up on the news and it appears that bond yields are now rising in Australia as well as the US.
Yet another warning sign that a correction is imminent.

Kate

colin_twiggs

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Monday, May 28, 2007 - 10:58 am:

Confirmation from 10-year yields would help. They have not yet broken the downward trendline.

Regards, Colin

tnx

Though the fact that the current (2002 - 2006) reaction is slow, compared to the normal sharp reactions in a bear market (as in 1994 & 1999), suggest that the market has changed. Difficult to call a reversal on this alone, however.

(Message edited by colin_twiggs on May 28, 2007)

kate

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Monday, May 28, 2007 - 12:01 pm:

Colin,

Thanks for posting the chart. I should have put in the link with my previous post which I'll do now. If the data is correct I think it indicates the trendline has been broken.
What do you make of it?

http://www.theaustralian.news.com.au/story/0,20867,21803397-643,00.html

Regards
Kate

colin_twiggs

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Monday, May 28, 2007 - 12:32 pm:

Kate,
The article refers to the gap between Australian and US 10-year bonds.

I can see where Bill is coming from on the 30-Year bonds, but would like confirmation from the 10-Year TNX.

Regards, Colin

tyx

kate

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Monday, May 28, 2007 - 01:22 pm:

Colin,

The way I interpret the article may not be correct but to me it seemed as though Paragraph 1 is unrelated to Paragraph 3 and 5.
I'd love to get my hands on the information he used for the article.
Posted a link to the TNX. Would a move above $49 be confirmation?

Regards
Kate

http://www.marketwatch.com/tools/quotes/intchart.asp?symb=TNX&time=8&freq=1&comp =&compidx=aaaaa%7E0&compind=&uf=0&ma=&maval=&lf=1&lf2=&lf3=&type=2&size=1&txtsty le=&style=&submitted=true&intflavor=basic&origurl=%2Ftools%2Fquotes%2Fintchart.a sp

colin_twiggs

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Monday, May 28, 2007 - 01:44 pm:

Kate,

That is 12 months compared to 15 years on my earlier charts.

Regards, Colin

kate

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Monday, May 28, 2007 - 02:14 pm:

Colin,
Apologies

Regards
Kate

http://www.marketwatch.com/tools/quotes/intchart.asp?symb=TNX&time=20&freq=1&com p=&compidx=aaaaa%7E0&compind=&uf=0&ma=&maval=&lf=1&lf2=&lf3=&type=2&size=1&txtst yle=&style=&submitted=true&intflavor=basic&origurl=%2Ftools%2Fquotes%2Fintchart. asp

colin_twiggs

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Monday, May 28, 2007 - 02:23 pm:

From what I can see, the peaks appear the same as on my TNX chart earlier.

Regards, Colin

colin_twiggs

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Monday, May 28, 2007 - 03:20 pm:

A rise above the 5.25% high on TNX and 5.30% on TYX would signal a change in the long-term trend. Much safer than a trendline break.

Regards,
Colin

kate

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Tuesday, May 29, 2007 - 11:01 am:

Thanks Colin,

Still looking for charts of Australian bond yields, will post a link if I find anything.

Regards
Kate

kate

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Wednesday, June 13, 2007 - 12:31 pm:

Quick update - TNX now 5.28 and TYX 5.38

I'm surprised at how fast they have risen. Greenspan giving them an added boost with his comments yesterday.

http://www.bloomberg.com/apps/news?pid=20602007&sid=a9iKxh02VvU4&refer=rates

kate

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Monday, July 02, 2007 - 09:50 am:

Colin, can you help me out with a query?

I was reading an article this morning about Treasury Bonds and it was saying that an increasing yield didn't necessarily equate to an increase in inflation (and therefore interest rates). Instead, it can be the result of a lack of buyers of T Bonds.

What they didn't say was and what I would like to confirm,
is whether the Fed then has to artifically increase the yield to attract buyers?

Many thanks
Kate

colin_twiggs

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Monday, July 02, 2007 - 10:16 am:

Kate,
T-bond yields are a function of supply and demand.
(i) Demand will fall, driving up prices if interest rates are expected to rise. It also falls when equity markets are strong.
(ii) Demand rises when rates are expected to fall or equity markets weaken. Also when carry trades increase - hedge funds borrow in low rate currencies such as the yen and invest in high yield currencies such as the US and Aussie dollar.
(iii) Supply is in the hands of the Fed. They can float new issues or intervene in the market to buy back existing issues.

Regards, Colin

kate

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Monday, July 02, 2007 - 10:19 am:

Colin, can you help me out with a query?

I was reading an article this morning about Treasury Bonds and it was saying that an increasing yield didn't necessarily equate to an increase in inflation (and therefore interest rates). Instead, it can be the result of a lack of buyers of T Bonds.

What they didn't say was and what I would like to confirm,
is whether the Fed then has to artificially increase the yield to attract buyers?

Many thanks
Kate

resillent1

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Thursday, August 07, 2008 - 10:56 pm:

The statement following the RBA meeting on Tuesday has managed to send the BBSW yield curve negative.

'In theory there's no difference between theory and practice. In practice there is.' - Yogi Berra

"Just as man working with a tool has to know its limitations, a man working with his cognitive apparatus has to know its limitations." - Charlie Munger

resillent1

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Wednesday, August 20, 2008 - 11:45 am:

Dean

I hope you find the this here - I have had enough bread on a daily basis - starting to develop quit a wheat intolerance.

The money flow response to yesterdays RBA minutes was - well no response, seems all the action happened following the statement with nothing new in the minutes.

My interpretation is pretty much as you put it in your post. It just common sense really.

The only other observation that I have made is that the BBSW rate curve often leads the RBA cash rate changes. I don't think the RBA follows the market; its more a case that the RBA generally doesn't like to surprise the market so there is enough of an indication prior, that the market correctly anticipates the direction. To that extent the statements, minutes and various speeches are much more important than an actual shift.

The cash rate is a target and the RBA operates to have overnight loans between financial intermediaries mimic their desired cash rate. These overnight rates are the base on which the structure of interest rates in the economy is built.

Effectively we have already had our first real rate cut back on the 5th August when the RBA first signalled its change in stance. Currently the market is saying that a discount is needed to lock in beyond about six months on current information. (shorter really if you expect extra reward for extra time(normal yield curve)) Shorter terms will move as and if the RBA talks/acts further)

This is just my opinion – I’m no expert.

Date	1 mth	2 mths	3 mths	4 mths	5 mths	6 mths	9 mths	1 yr

20 Aug 08	7.3267%	7.3183%	7.2900%	7.2983%	7.3000%	7.3000%	7.1700%	7.1300%
19 Aug 08	7.3150%	7.3100%	7.2833%	7.2850%	7.2833%	7.2800%	7.1517%	7.1200%

Ps my definition of an expert: (ex-spurt)
Ex – a has-been
Spurt – A drip under pressure

deanrosario

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Wednesday, August 20, 2008 - 12:24 pm:

Wonderful analysis resillent1 - exactly the type of insights for which I was hoping.

Thanks for taking the time to provide the link - I would certainly have missed it!

Dean

"Never commit yourself to anything you can't walk away from in 30 seconds." Neil McCauley (played by Robert de Niro) in 'Heat'.

"Hope is a dangerous thing. Hope can drive a man insane." Ellis Boyd "Red" Redding, played by Morgan Freeman, in 'The Shawshank Redemption'.

colin_twiggs

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Wednesday, August 20, 2008 - 03:01 pm:

Kate,

Apologies for missing your July 2 question:

kate wrote on Monday, July 02, 2007 - 10:19 am:
I was reading an article this morning about Treasury Bonds and it was saying that an increasing yield didn't necessarily equate to an increase in inflation (and therefore interest rates). Instead, it can be the result of a lack of buyers of T Bonds.

What they didn't say was and what I would like to confirm,
is whether the Fed then has to artificially increase the yield to attract buyers?

Lack of buyers can be a result of rising inflation expectations. Whatever the cause, the yield will rise until sufficient buyers are attracted to establish a new equilibrium (the beauty of a free market).

Regards,
Colin

(Message edited by colin_twiggs on August 20, 2008)

kate

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Wednesday, August 27, 2008 - 10:11 am:

Resillent, below is a copy of my post in The Daily Bread section. I've been meaning to thank you for posting the graph above. Do you have a link for the site that it came from or could you post an updated version?

Many thanks
Kate

Hi Dean

When Resillent posted a graph showing that bond yields had inverted I did some more digging. Bond yields(inverted) are supposed to be a leading indicator for an impending recession. Unemployment, Corporate profits and Labour cost/unit of output are lagging indicators.

So, I've actually been paying attention to the reporting season this time, not individual companies but overall trends. The article put it all together rather nicely. I don't know if you had noticed but there are more companies sacking a proportion (or all) of their staff. Yesterday's announcement by Fairfax to sack a third of its workers should send a shiver down the spine of the business community.

Whilst we mightn't be in a recession yet, it does indicate business conditions have deteriorated considerably.

Regards
Kate

kate

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Wednesday, August 27, 2008 - 10:14 am:

Colin,
Thanks for your response, I forgotten about that post!

Regards
Kate

resillent1

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Wednesday, August 27, 2008 - 12:24 pm:

Hi Kate

Yields still inverted, the one month rate is still declining so first cut is likely to be sooner rather than later.

The access I have to BBSW data is due to the relationship I have with my bank. I'm not sure if the data is freely available anywhere. Iress platforms have the info if you have the access.

kate wrote on Wednesday, August 27, 2008 - 10:11 am:
paying attention to the reporting season this time, not individual companies but overall trends

I have been watching at the individual level, and the disparity is huge.

Valuations are relatively low now across the board, but as the earnings cycle heads down and affects companies differently, the current low valuations for some companies are going to prove not low enough, whilst other companies with more robust earnings are good buys at this level.

I think this market is a stock pickers playground. Broad-brush approaches are going to have to wait for some time though.

Cheers

Only $12 (USD) per month

kate

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Wednesday, August 27, 2008 - 01:51 pm:

Thanks for the update Resillent.

From what little I've read there seems to be only a handful of companies with good prospects. WOR, I think LEI was mentioned, JBH and several others which I can't remember. My concern, even with those companies is credit squeeze. If we end up up with a freeze in interbank lending again they'll be hit along with every other listed company. Already there is talk of a slowing down in the Middle East(Dubai mainly, where WOR and LEI have big interests)and these are the countries who are swimming in petrodollars. So, even though there is ample money, banks aren't lending.

I'm probably more pessimistic than I need to be, I don't know!

Kate