When yields on short term Treasury instruments exceed the yields for those for longer terms, the Yield Curve is said to be inverted. That doesn't happen very often, but when it does a recession often follows.
     Today, the Yield Curve is inverted. Let's hope it straightens out tomorrow. (Scroll down the linked page to see the graph.)
Sean

Sean,

How about this question; How effective is the FED's raising of short term rates when the yield curve is flat or inverted?

I think maybe we are seeing some propaganda on inflation that is not showing the reality. The current spinners like to focus on the "core" rate excluding that terrible energy and food since it is too "volitile". But we know that long term energy prices raise the prices of everything. I got some sticker shock at the grocery store the other day. I was picking some avocados on sale for a mere 10 for $10. I thinking how lucky they were on sale (with store card) since the "regular" price was $1.69 each. Then I remember that in the not too distant past $1 or over was the price at which I would not buy.

One trick I have been noticing much more lately, maybe because prices are going up, is that most sales are combined with a price increase. They are training us. Say an item cost $2 last month. You see it on sale today for $1.95, down from a "regular" price of $2.50. Sure you save a nickel from last month but when you go buy it next month you are not surprized at the $2.50 price since they already put it in your mind that is the regular price so you are less likely to notice the increase. Have you noticed that?

I had a funny typo in first draft instead of "The current spinners" I typed "the current sinners". Freudian slip?

BullDoug,
     The inversion is even more pronounced today with 6-month yields exceeding that for 5-year bonds. I think we're in for a recession.
     Inflation can't forever be concealed by excluding "volatile components" such as energy and food. People are aware of that: Note how quickly the dollar fell against the euro and the yen at the mere suggestion that the "measured increase" in interest rates might stop. I'd say it is inevitable that the current sinners will continue sinning.
     As for me, my present strategy is to observe things from the sidelines until the January hysteria subsides. When we're back to doldrums, I will resume investing.
Sean

quote:

The inversion is even more pronounced today with 6-month yields exceeding that for 5-year bonds. I think we're in for a recession

If I'm reading it right it looks a little more sensible today.

quote:

Note how quickly the dollar fell against the euro and the yen at the mere suggestion that the "measured increase" in interest rates might stop.

Europe and Asia have been growing fast and most of them are looking at increasing rates which in relation to the US makes them more attractive should the FED stop lifting rates. I think was part of what we saw.

quote:

I'd say it is inevitable that the current sinners will continue sinning.

Can't argue with that.

quote:

As for me, my present strategy is to observe things from the sidelines until the January hysteria subsides. When we're back to doldrums, I will resume investing.
Sean

Well, I was fighting the battle of the investing maxims. The "Santa Claus rally" vs. "Don't fight the Fed". The Fed may in the last round and be heading for the showers but I didn't see much in store for the Holidays to drive the market higher. I AM seeing earnings estimates and forward looking estimates suggesting an S&P 500 P/E of 16 for next year. Currently we are at 19. Historically 14-16 would be normal, 19 high. A P/E of 19 can be justified with higher growth and we have been at 22 at times last year (I sold). But growth can be judged as a function of interest rates as well and those are in an up trend.

So I have a whole bunch of "On the other hand(s)". I was rebalancing on 01/02 and just took a shot. I'm all in. I had about 30% cash and committed it all. Then I got over a 1% bump on Tues and now it is holding. (365% annualized? wow!)

Okay, okay I'm not getting a percent a day after that.

Worse I may not get the percent. They state I get the price at the "close of business next day". But in the past when I made weekend fund trades I have received the previous price so it remains to be seen.

I went all in based on just a "gut" feeling and I was moving money anyway. I also fell victim to something I saw cautioned against in an investing advice article and that is "False numerology". Meaning; Making decisions based on a particular number, i.e. "I will sell the stock as soon as it doubles". You should base your decisions on the stock, the company, and not the profit or any given arbitary number.

But putting in all my cash made the rebalancing all nice and even, and even numbers too. HAHA so I'm guilty.

I do have the impression my "magic" number (currently 1260's) has been a resistance number so often it is due to push through it. I think have figured out why that number has been so important: It coincides with DOW 11,000 and that has been a tough psychological point to cross. I think we are due. Plus the trend still is up.

And with all the pensions getting hit these days I also think there could be an "IRA effect" with more people funding retirements before Tax day. Anyway that's this years plan, idea, and then I will be looking to "Sell in May and go way".

Events can change these opinions at any time.

Good Investing to you,
Doug.

BullDoug,
     Look at the Yield Curve now. Isn't it a beauty? I think the time approaches to give some neglected stocks a home. P/E's are starting to look good! Dare I hope to see S&P 500 fall to 1100?
Sean

If the scale of the chart was not so narrow the curve would look real flat to me, only a little inversion with the shortest rates.

But flat is not all that much better than inverted considering how low the rates still are overall.

High short term demand is not so bad.

I wonder if all the disenchanted investors that lost money in the bubble burst might not be distorting the curve. I know of an awful lot of money that went to bonds and stayed there.

What about demographics? The boomers will have most of the money in the next few short years. Could they be getting very conservative and buying bonds?

I wonder why all the deficit spending hasn't pushed the rates up more. Is it because of China? It was that 75% of treasuries were owned in the US. Now it is 50%. (Not sure if the figure was newly issued purchases of debt or in total.)

BullDoug,
     To me the Yield Curve seems to be a good indicator of the expectations of people who actually have money. Bearing in mind that the price of treasuries is related inversely to their yields, and that their price depends upon demand, it looks as demand for long-term issues is high--high enough to nullify the interest premium that compensates for the risk of committing funds for lengthy periods. Thus, when long term yields go down, it means investors do not feel threatened by a possible inflation and want to lock in present yields, small though those appear to be. In other words, they're betting that future interest rates will be lower than treasuries are paying now.
     On the other end of the curve, short-term interest rates are high and rising. That tells me people are expecting a sharp drop in rates within the next six months and don't want to be caught with uninvested cash at a time when yields are low. I see, however, that 3-month T-Bills are greatly in demand, which suggests a time-frame between 3 and 6 months from now when the Fed is expected to start lowering rates aggressively.
     That will only happen if there is a real recession and cheap money is required to stimulate the economy.
Sean

     The Yield Curve has reverted to its normal upward slope from short- to long-term. The difference between the yields of 30-year bonds (5.05%) and 3-month Bills (4.86%) is only 0.18%; much too small to make me opt for the longer terms.
Sean

quote:

only 0.18%; much too small to make me opt for the longer terms.

More money is more money. But yes that is a very small risk premium. Then again...

Bonds had been running less than 1% over inflation. Now they are at 1.5% or even a little better. So your real return is up 50% in the last year or two. That is big. It is now at a more average historical return. If I recall correctly between 1% and 2% over inflation is the normal range. So inflation is currently the nemisis. Comparing the 0.18% on a real basis, to the previous 1% real return it is around a 15% real premium. Not as miserly as it first seemed.

I think with a little more premium I could be convinced to go with the 30 year bonds, in a brokerage account. I would not want to buy them direct because I would want to be able to quickly sell them on the secondary market should inflation be a threat.

But attempting to predict inflation over 30 years is near impossible. Once again, as with most investing (and as I have said before), we are back to discussing risk while most only wish to discuss return. And risk, IMO, is the more important of the two in the Risk/Reward ratio.

The FED is not signaling a slow down in rate increases. Some noise is still about risk of inflation.

The higher energy prices may be working in to the prices as I mentioned last Dec., (above).

A possible slowdown in the months ahead is hammering stocks and long rates are falling some.

It looks to me like an Inverted Yield Curve is a risk again.

And dare I whisper the "S" word? (stagflation)

FWIW

I have lost a lot money this past month with the stock market tumble (live by the sword, die by the sword) but todays almost 200 point drop and then recovery to a gain is typical bottoming action, a blowout. I will be checking the volitility and options for confirmation.

BullDoug,
     Stagflation is certainly a possibility.
     I'm sorry to learn about your market losses. Of course you'll be very careful about responding to false buying opportunities. I see no reason to suppose the current sell-off has reached a bottom yet.
Sean

Sean,

Please, no sympathy needed. I only lost some gains and I'm still way ahead for the year thanks to some good timing.

As much as I benefit from the risk I have to take the downside in stride as well. If one can't they shouldn't take as much risk.

But I should have heeded "Sell in May and go away" for the summer months. May to Oct. I am still figuring as flat, as is the usual case.

But the market is still pricey as it has been since the bubble. But it can stay pricey for very long periods of time with growth resulting in gains over that period.

I had been too complacent recently and will now have to take a closer look at where we are and where the market may go.

Are you still staying with short bonds?

BullDoug,
     Yes, still with short-term instruments. I really see no reason to make a change. You're right about the Yield Curve. I read that as investor appetite for long-term safety so strong it's driving interest down. Not so for 6-month bills. No one seems to want them,
Sean

     Well, the Yield Curve briefly returned to normal and then inverted once again. Buying long-term for 5+% yield makes it look like the money people are not expecting much in the way of further interest rate increases. Is it time for the Fed to quit worrying about inflation and begin working to avoid recession?
Sean

Looking at this thread, the yield curve has been inverted or flat for three quarters of a year now. That's seems too long. I wonder what is different in this current cycle.

BullDoug-
     Those low yields on Treasuries are telling us the prices of notes and bonds being driven up by investors looking primarily for safety. During the housing boom, much of that money would have gone to finance mortgages but the boom is ending now and the price of homes is falling, which makes housing debt look risky to investors. That may account for the avidity with which Treasuries are being purchased. Does it seem reasonable to you?

     Next Monday there will be a T-Bill auction. I am expecting the yield on 6-month T-Bills to fall below 5% for the first time in a long while. I doubt stocks will be doing well at all, near-term, so where should a person go to make some money?
Sean

quote:

During the housing boom, much of that money would have gone to finance mortgages but the boom is ending now and the price of homes is falling, which makes housing debt look risky to investors. That may account for the avidity with which Treasuries are being purchased. Does it seem reasonable to you?

There is some logic in that. But that risk premium in housing should result in the divergence of long term treasury rates and mortgage rates. While there is some divergence, mortgage rates are still tracking treasuries. I read somewhere that China is buying mortgages, like Fannie and Ginnie Maes was well as our Treasuries and that is distorting our yield curve. It also makes the Fed's job more difficult.

The government is A okay with it because it hides the inflation that should be caused by our national debt and terrible trade balance. As long as the money comes back it is not deflating the dollar.

BullDoug-
     By divergence I understand you mean returns for mortgages should be increasing in order to attract scared money. Quite true, if the demand for loans is high. However, with the housing market in a slump, new loans may not be needed. Interest on savings accounts and CDs remain absurdly low; to me that says banks aren't out to get more money they can use for lending.
Sean

Jan, 2008 (first note in thread was Dec. 2006)

quote:

Originally posted by Sean:
     When yields on short term Treasury instruments exceed the yields for those for longer terms, the Yield Curve is said to be inverted. That doesn't happen very often, but when it does a recession often follows.
     Today, the Yield Curve is inverted. Let's hope it straightens out tomorrow. (Scroll down the linked page to see the graph.)
Sean

WOW, real nasty curve inversion at 2 years, currently.

Do we consider that current slowdown/recession as confirmation of the theory that a inverted yield curve predicts a recession?

What was the timing?

I don't see it at the moment but I thought they said 6 months to a year after an inverted yield we often have a recession. It looks like almost a year to the date from the first note if we consider the slowdown to have started this last Dec..

WOW, that bad inversion in the yield curve was a great predictor!

It is back to being rather steep again, at least up to 5-10 years.

Long term is still flat predicting low inflation and weak growth for a long time?

quote:

Long term is still flat predicting low inflation and weak growth for a long time?—Doug

     Predicting weak growth for sure. I don't think people are allowing for the imminent inflation due to governmental rescue projects. That will be overwhelming.
Seán

quote:

(first note in thread was Dec. 2006)

Long term perspectives....

It is now a little over three years and three months since the first post in this thread and the yield curve is now with a solidly upward slope and the high end ticking up some today after the first of three treasury auctions this week.

It is predicting better times ahead (with some inflation). But the inversion looks to me to be gone.

That is the longest time I can ever recall the yield curve staying that inverted that long. It has also been the longest recession in our lifetimes as well.

http://www.bloomberg.com/markets/rates/

My "dumb money" mutual fund index is showing fund flows 3 to 1 into bonds. Is the majority always wrong at turning points? That was my premise for a long time.

The way that should play out (in theory) is when you get the buyer capitulation of the dumb money shifting back to stocks you should see a blow out and a top. It looks like we are a long way from that but higher rates and future bond fund losses could change that.

It might take a lot to change behavior though as most retail investors are still licking their wounds of the last few years.

But for now, it all says it is still buying time to me. Although I am starting to fear a short term correction for stocks as we may be ahead of ourselves.

Doug,
     I think it is more scared than dumb money. Memories of the last crash are still fresh in people's minds. You're right to expect a sell-off; fear will be the driving force. If it comes I will hold the portfolio I have and plan on buying more shares somewhere near the bottom.
     To me the greater threat is incipient inflation. Sound equities should retain some value even if cash does not.
Seán