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Comment by NTDF9 | Hacker News Reader

Can someone concisely explain what yield curve inversion could indicate?

I can think of a few explanations for why long term yields are going lower:

1. Long term yields going lower because there are far fewer places for capital to go to besides US treasuries, indicating slower business activity

2. Short term yields going higher because no one wants to buy short-term treasuries because there's something else to invest in or expect higher return for short term investment?

Are these the only two reasons? Why are people so fearful of inverted yield curves?

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Investors want to buy long term bonds because they suspect the interest rates will get worse, so they want to lock in the current rate for a longer time. It signals that investors are expecting a recession.

People are fearful of inverted curves because it means the market is pricing in a predicted recession. Of course, that does not mean that a recession WILL happen, just that it's the current market expectation.

During recession scenarios, the Fed cuts interest rates to facilitate borrowing and inject more capital into the economy. So a lower 5yr rate means the market is expecting a more aggressive monetary policy in 2023

Inverted yield curves mean that interest rates are expected to fall. Interest rates falling mean that (a) demand for money is falling and/or (b) supply of money is rising. In economic recessions, the demand for money often falls and the supply of money often grows. Therefore, an inverted yield curve indicates an increased forecast of recession chances over the next few years.

(I am not an expert and could be wrong.)

Good explanation. Thank you.

But isn't the demand for money going to go up because the US is running ginormous deficits? I would expect the demand for money to be through the roof.

[Edited] As described by the IS-LM model, government deficits tend to do three things:

-Increase output (more people working/getting paid)

-Decrease economic investment (investors put dollars in treasuries instead of private sector projects)

-Increase interest rates (fewer investor dollars to go toward private sector projects, since some have been diverted to government debt/production)

However, the Fed usually tries to account for this force in their monetary policy (see monetary offset):https://www.bloomberg.com/opinion/articles/2018-07-20/fed-im...

Doesn't debt issued by US treasury have to be funded by private holders of US dollars? Or does the Fed simply buy out the debt issued by treasury?

I thought the Fed simply buys only a small portion of US treasury debt (thus printing money) but the vast majority of that treasury debt is purchased by holders of US dollars (banks, funds, China, Japan etc.)

Yes, debt issued by the US treasury is funded by private holders of US dollars.

Here's how I think it works:

-In theory, the Federal Reserve targets average inflation of 2% (along with its unemployment mandate)

-When the US government runs a deficit, the government sells bonds and uses the dollars to pay whatever it's paying for

-This process soaks up dollars from investors and gives out dollars to people, which on net lowers investment, increases interest rates, and increases GDP (see IS/LM model: https://en.wikipedia.org/wiki/IS–LM_model)

-The Fed, which aims to stabilize inflation, accommodates the rise in interest rates by setting higher target rates for its open market operations (if they fought the movement in interest rates by buying assets, inflation would rise, which is against their mandate)

How selling bonds soaks dollars from investors?

If you go to a bank and ask for a credit for starting a business, if the bank approve of your project, they will credit your bank account with new money. That money is new created money.

How is that related to more or less bonds sales?

If investors spend their dollars on government bonds, they have fewer dollars to spend on other investments. The lower supply of investor dollars for these investments causes interest rates to rise.

yes, but interest rates help drive supply of money, not the other way around. lower interest rates give cheaper access to capital which drives a higher supply.

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