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Why is the Yield Curve Flattening?
Topic Started: 10 Aug 2014, 09:44 AM (811 Views)
peter fraser
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Why is the Yield Curve Flattening?

By Cullen Roche· Comments (3) · Saturday, August 9th, 2014


Scott Sumner asks an important question – why is the yield curve flattening? Scott thinks it’s because of a faster decline in the unemployment rate at a time when the pace of NGDP growth is slowing:

Quote:
 
“The rapid fall in unemployment explains why a rate increase is expected within less than a year, and the declining estimates of trend NGDP growth explain why rates are not expected to rise as far after that first rate increase.”


I don’t know. As someone who trades a good bit of fixed income I think that view overcomplicates how the markets actually set the price of yields. Most fixed income traders view long rates as a function of the economy and short rates as a function of the Fed’s views on the economy. So, when the Fed increases rates it means that the Fed thinks the economy is improving and needs some tightening so it doesn’t cause the Fed to create too much inflation and overheat the economy. But fixed income traders account for this and front-run the Fed’s thinking by trying to anticipate their views on the economy. Said more simply – long rates are a function of short rates for the most part. And the fact that long rates are remaining low means that fixed income traders increasingly believe that we’re in a permanent state of low interest rates.

There’s some data that would seem to confirm this view. First, the standard deviation of yields has fallen over the course of a 6, 12, 18 and 24 month period. This means that traders are becoming increasingly confident in the stability of the low interest rate environment. If there was a strong likelihood of much higher rates in the future then this wouldn’t be happening. Rates would be much more volatile as the future interest rate environment would be far less certain.

In addition, future inflation expectations have essentially flat-lined. This means that bond market really doesn’t see high risk of inflation in the future. So, if inflation is the driving force of future rate hikes (which is a logical assumption given that the unemployment rate is still historically high) then the bond market is showing very little signs of worry about future inflation. Of course, none of this means that bond traders are right and they could be misinterpreting the future, but I don’t think the story needs to be overcomplicated.

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Edited by peter fraser, 10 Aug 2014, 09:45 AM.
Any expressed market opinion is my own and is not to be taken as financial advice
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Jimbo
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peter fraser
10 Aug 2014, 09:44 AM
And the fact that long rates are remaining low means that fixed income traders increasingly believe that we’re in a permanent state of low interest rates.
I think the FED and BoE are jawboning on rate increases with no intention of actually raising them. The BoE have been projecting increases for over a year to give weight to the illusion of economic recovery. They always find an excuse not to raise them though. First they targeted an unemployment rate and when that was met, they moved the goalposts to inflation and now they are targeting wage growth.

It doesn't take a genius to work out that the FED, BoE and ECB have no intention of raising rates.
Matthew, 30 Jan 2016, 09:21 AM Your simplistic view is so flawed it is not worth debating. The current oversupply will be swallowed in 12 months. By the time dumb shits like you realise this prices will already be :?: rising.
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Count du Monet
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Going by their past performances the FED won't raise rates significantly until long after the horse has bolted! :D
The next trick of our glorious banks will be to charge us a fee for using net bank!!!
You are no longer customer, you are property!!!

Don't be SAUCY with me Bernaisse
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Jimbo
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Count du Monet
10 Aug 2014, 11:53 AM
Going by their past performances the FED won't raise rates significantly until long after the horse has bolted! :D
They want the horse to bolt. They want it to run away without anyone noticing and they will do everything they can to cover up the fact.
Matthew, 30 Jan 2016, 09:21 AM Your simplistic view is so flawed it is not worth debating. The current oversupply will be swallowed in 12 months. By the time dumb shits like you realise this prices will already be :?: rising.
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Black_Dragon
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Its a low inflationary outlook, which in itself has been brought on by massive supply side expansion globally on all types of goods and services.

Plus there is the issue of too much debt in the system. We all know total Debt to GDP has risen over the past 20 years for the majority of countries. And that is now constraining aggregate demand as we go about servicing and slowly paying off that debt.

Another way to look at it now is asking yourself this - could our economy handle the cash rate at 6% again?
"No sympathy for the devil; keep that in mind. Buy the ticket, take the ride...and if it occasionally gets a little heavier than what you had in mind, well...maybe chalk it off to forced conscious expansion: Tune in, freak out, get beaten."My Webpage
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Count du Monet
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Black_Dragon
10 Aug 2014, 12:11 PM
Its a low inflationary outlook, which in itself has been brought on by massive supply side expansion globally on all types of goods and services.

What the financiers count as inflation is rising common prices, wages, common goods, trinkets for the plebs. They don't count rising asset prices as inflation even though it is. A warning, inflation and deflation can live next door to each other. The finance markets dream of goldilocks, a broad pathway between the two. Now I'd say it's a razor edge.

However energy prices certainly are on the rise, so I'd take any claims of low inflation with a grain of salt. And the expansion of supply from new markets like China has already peaked.
Edited by Count du Monet, 10 Aug 2014, 01:03 PM.
The next trick of our glorious banks will be to charge us a fee for using net bank!!!
You are no longer customer, you are property!!!

Don't be SAUCY with me Bernaisse
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Jimbo
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Black_Dragon
10 Aug 2014, 12:11 PM
Its a low inflationary outlook, which in itself has been brought on by massive supply side expansion globally on all types of goods and services.

The supply side is now weighted towards low wage economies and that is why we haven't had overall inflation increases. Most of our inflation has been in locally produced goods and services offset by cheap TV's and badly made Reeboks.

However, will the Chinese want to work for $2.00 an hour forever? Now we don't make cars and sew our own clothes, do the Chinese really need to compete on price only? There is no one to compete with.

Chinese unit labour costs are going up and that is where our inflation will come from. It won't be too much money chasing things (normal inflation), it will be that things cost more. You can't really control that kind of inflation with interest rates.

Matthew, 30 Jan 2016, 09:21 AM Your simplistic view is so flawed it is not worth debating. The current oversupply will be swallowed in 12 months. By the time dumb shits like you realise this prices will already be :?: rising.
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