The yield curve as a leading indicator
newyorkfed.org
newyorkfed.org
I psychology of inflation is different than the past, because people have so little experience with it and don’t really believe in it.
It used to be that inflation fueled spending because people figured they should buy it now because it will cost more later. They’d figure there is no point in saving because the value of money will get eroded.
Today people see a Big Mac meal costs $9.99 at McDonalds and think “I can’t afford that!”, gas is $4.99, diesel is close to $7 and people think they have to stop the bleeding by hitting the brakes on consumption.
I think supply chain problems are taking a bite out of demand. I have wanted to buy equipment for my photography/art hobby and I can’t get it. I am saving money until it is available, not buying something else.
I would figure investing it is better than buying crappy food or holding dollars that are losing purchasing power. Maybe there was no VOO or VCSH decades ago, but it is an easy no brainer nowadays.
You would have to wait for stocks to double to break even, which can be a long time.
Your argument always assumes you pick a point in time and never consider new information or fundamental information. Such as, there were less computers doing things in the world yesterday than today and there'll be more tomorrow. Seems like a reasonable investment over the medium term.
The 2010s were a great decade for stocks, the 2020s might not be. That too changes the psychology.
The good times in stocks were supported by very low interest rates, which some people call "financial repression" -- despite that there was tremendous demand for "stablecoins" (government bonds) even at negative real interest rates.
Even if you believe conditions are right for technological and social progress, interest rates will be a headwind for the stock market if they revert to the mean.
I hear this a lot. Its true that stock returns relative to inflation weren't great, but what was better? I mean, cash lost a huge percentage of its value. Stocks seemed to pace inflation.
Were bonds a better investment during this period?
Harry Browne, who ran for president as a libertarian suggested using gold as a hedge
https://www.investopedia.com/terms/p/permanent-portfolio.asp
The "all weather" fund from Bridgewater is similar in thinking but substitutes inflation-protected bonds for gold.
If you couldn’t turn a profit during practically the best time for tech startups in 2020-21, I can’t see how you can turn a profit when money is much tighter.
Online/software-heavy services, tend to be fairly short runway (nothing like the decade plus typical for biotech firms), but still aren't generally zero runway to profitability.
4 trillion more and doubled since the start of 2020 is crazy.
If it’s a year to a few years, high quality bond ETFs likes VCSH should do the job.
If it’s further out than that, then sink the money into broad market equity ETFs.
And, who knows, we may have already experienced the bottom.
Isn’t that more of a class distinction than a decision for most people? The rich will invest either way, and the poor won’t. Both will buy food. The economy still runs on consumption (which is kinda required for investment to even work, right?)
> it is an easy no brained nowadays
I’m a little skittish on making new investments at the moment, and it seems to be going around? You’re saying that’s obviously foolish and people should be investing right now despite potential indicators of a recession?
There are more than two classes. The bottom 60% might be running on fumes, but the 60% to 70% might be thinking about foregoing spending $2k on a road trip that they can choose to invest instead, and the 70% to 80% might be thinking about a $4k Hawaii trip that they would forego. And the 80% to 90% might avoid $10k on an international destination. And the 90% to 95% might choose to invest $5k in the market instead of buying first class seats and put an extra $50k in an IRA as opposed to a new car.
> You’re saying that’s obviously foolish and people should be investing right now despite potential indicators of a recession?
Yes. Buy low, sell high. If you need to sell within a few years, then stick to cash or bonds. Although, what I actually meant by “easy no brainer” is that it is dead simple to invest in all equities at basically no cost due to the availability of extremely low cost broad market ETFs like VOO. Anyone can invest in the whole market for cheap within seconds of logging into their brokerage account.
As I wrote in another comment, for money you need within a year or two, stick it in an FDIC insured saving account, for money within a few years, put it in VCSH, and for money you do not need for a long time, put it in VOO or VTI or similar and forget about it.
On the flip side, eating at McDonalds in the first place is generally speaking a class indicator. I assumed that was the reason @PaulHoule used McDonalds. Foregoing McDonalds is quite unlikely to result in having enough cash to invest in something else. You still have to eat, and a lot of foods are more expensive than McDonalds even from a typical grocery store.
I suspect that's going to start up again soon.
I highly doubt this was ever the case, rather than what some orthodox econ types told themselves without evidence.
More broadly, if there was price stability for single family homes, buyers would be outraged!
My home's value has gone up over 30% since I bought it around 18 months ago (and 50% since 3 years ago) - I couldn't afford to buy my own home if I were house shopping today.
If there was price stability for homes, people buying them for living in rather than as investments would be happy, since affordability would increase with real (or even nominal, depending on the sense of “stability”) wages.
There are reasons to buy besides price appreciation.
It's not a complex economic environment out there. You can look at a very small set of numbers and get the picture; buffet-index (total market value to GDP) and GDP growth in dollar terms says the market is high. CPI, M1 money supply, and debt-to-GPD says the dollar will reduce in value. So where else you going to park your money? If there's machines you can use, that was a good time. Most people don't need machines so it's all about houses and land and anything not showing as much peak. Not academic; critical to maintaining the value a person has put into savings from all that labor.
If you are looking to cache out of the stock market, that's quite different: you were worried about both inflation and the stock market falling after a bubble.
Most people have negligable liquid savings. Even if they wanted to, they lack the means to do what you did. Your behavior is anomalous and not representative of a broader macroeconomic trend.
As your post highlights, it gets more complicated the more factors one considers, like disposable income, stock ownership, etc. What you're describing here is rudimentary, not some groundbreaking, econ-slaying assertion.
I would say it is pretty damning.
Moreover, even if we had a good paper that corroborated what you have here, I'm sure you probably realize that it takes more than a single paper, or even a handful of papers, to declare some truth finalized. "Pretty damning." Come on, dude.
Yes, the paper itself isn't a turning point, but the claims of the paper, if one chooses to accept them, are damning. A science should never confuse theoretical prediction and empiric evidence.
Indeed, other agencies like the FDA make the opposite mistake e.g. insisting on endless RCTs for e.g. JJ + mRNA booster vaccine when the theory-based extrapolation from other evidence is simple, and the opportunity cost of waiting non-negligible.
It is bad and quite odd given the overall trend of science towards "mindless empiricism" that Econ has the opposite problem!
> Most people don't need machines so it's all about houses and land and anything not showing as much peak.
You didn't see housing as showing as much peak?
I still paid for it and justified it in my head that this is the first time I’ll be traveling in two and a half years.
But if I had to do it again, I can’t justify it at all. There has to be some level of “spite spending” from two years of pandemic as well - people who know that they’re overpaying but they do it anyway because they’ve been locked up for two years.
I mention this because I think these cycles have profound effects on economic variables like spending, credit use, etc. Your commend about "spite spending" fits perfectly with this--yes, household balance sheets are deteriorating, but people are just sick of covid, they want to take a vacation, and get outside.
I think a similar thing drove housing in the 50s, actually. It's easy to look back on the mid-century dynamic as "boring", "sterile" even, but WWII ended in the mid-40s, and if I'd spent a year of three getting blown up in Europe or Japan, a quiet house in the suburbs is exactly what I'd want.
How is eldavido supposed to tell the societal impact of 9/11 apart from the fact he graduated high school that year?
But it's more than just a feeling. Keynes was writing in the 1920s/1930s about "animal spirits" driving the business cycle. Read Ray Dalio's stuff on credit cycles. Collective psychology drives a lot of carefully measured phenomena, things like savings rates, credit growth, unemployment, etc.
I spend probably 4-6 hours/week reading professionally edited, long-form journalism. In all honesty, I'm not sure it's a great use of time, but I can tell you all about things like the UK's no confidence vote on Boris Johnson, or why the "Red wall" situation in the UK reminds me of Michigan and Pennsylvania in the US, north vs south Europe's views on the EU's 750 billion NGEU stimulus, the performance of Nordic sovereign wealth funds, or why the expiry of the US's child tax credit was catastrophic in terms of poverty reduction.
Point being, if you really immerse yourself in good news for a couple decades (I've been reading at this frequency for ~20 years), it trains you toward a healthy baseline of what's "normal" vs. exceptional.
I was talking to my wife last week, telling her that at this point, at least as it pertains to economics, I usually know what "normal" means (e.g. GDP growth, unemployment, etc), and I know what's "weird" about the present day, but what I haven't yet figured out is what stays the same over time vs. what changes. Take US interest rates. The 10-year treasury note was around 1.00% 18-24 months ago. That was low. Now it's in the 3s, which is still fairly low. What I can't figure out is whether this "lowness", which is historically bizarre, will continue this way, or if there's some permanent structural change (e.g. more elderly savers relative to young users of capital) that has permanently altered the equilibrium. That does seem pretty hard, though.
[0]: https://d3f7q2msm2165u.cloudfront.net/aaa-content/user/files...
Similar is gas pricing. 10 cents cheaper if you have the app or gas station CC.
Sure they're cheaper, but do you really want to feel like you're going to court getting on the plane, arguing over how many personal items you're allowed, their size, etc? There is in fact a limit to what many people (including me) will put up with, at some point, you just want no change fees, no baggage fees, etc and pick Southwest.
Incidentally, when people talk about schools and healthcare, and suggest a one-size-fits-all model, I'm shocked they don't see how much peoples' preferences vary. If we can have so much choice and variety when it comes to something as stupid as air travel, it seems crazy we wouldn't want the same thing in healthcare.
I was told they have great results in preventing complications like infections, as they would not be able to bill additional costs to insurance.
I feel like they are a by-product of fare deregulation and the movement to self-directed online bookings. Like vermin before the invention of germ theory, they just appeared spontaneously on the market and nobody really planned it.
Deregulated fares eliminated the need and most of the opportunity for carriers to compete on experience. If PHX-ORD was the same price on every carrier, you're going to see all the marketing devoted to things like "nicest cabins, best food, most free amenities, most convenient schedule". That's a very hard message to maintain when 95% of customers start at a brand-neutral booking system and searches by price. I sort of wonder if they'd have succeeded in the age of agent-driven bookings, because agents would be disincentivized to recommend a carrier that's likely to yield bad reviews or loss of repeat business.
I think Southwest and JetBlue have done a moderate job of beating that cycle-- creating loyalty by promising "reliably slightly worse than awful". I know I'd preferentially book Southwest if I needed a flight just because I know I'm not going to be nickel-and-dimed with luggage fees.
Conversely, I don't think people's tastes for health care and education are as broad as you'd expect. There isn't anywhere near as much opportunity to "unbundle" features to try to hit a price target. Nobody says "well, if we can save $250 this year, let's not teach Timmy how to subtract", or "I want my surgery done by Steve, who just finished a three-week Coursera Tonsillectomy Bootcamp, rather than paying full price for Johns Hopkins."
Either use the local area code or a common one like NY (212) or LA (213).
7-11 is the best for this as there’s tons of people using it. At one point they had a free coffee every 10 promotion so every time you buy a coffee it was a 1/10 gamble to get a free one.
This is brilliant!
A physical menu magically appears.
1) They will not earn more money in the future to offset the price increases.
and
2) Their savings will outpace inflation.
Then they will react to inflation by saving more and deferring consumption. In order for this to change, saving/investment must generally be a bad deal for the average consumer - or they have to have the expectation that future earnings growth will offset inflation.
After 50 years of flat wages, it should be unsurprising that the average consumer does not believe 1 will be true.
Apparently homo economicus has an interesting digestive system. Does the Econ dept have an Anatomy book explaining how folks can eat 2x this year and then not eat next year?
I see this in my own life. I've eaten out for about 80% of my dinners. Taco Bell use to be $0.89 a taco. Now it's around $2. It took me 15 minutes round trip to get Taco Bell. My time (including fuel for the car) and food costs are now at or below $2 per taco (where I would get at least 3 for myself, two for my wife and 2 burritos betwixt us). I can eat steak and potatoes for the same total cost of a meal.
Homo economicus still has a digestive system. It's now considering the amount of energy (money) required to gather the food. Similar to the homo sapiens idea of, "Should I eat these nuts or get a pack of people to take down a bison?"
There's another aspect of this one..
There are people buying right now despite not being able to get their item because they're afraid it will cost much more later. Then they wait.
On the retailer's side, the responsible ones hold the money and count it as a liability (ha!) while the normal ones count it as revenue right now and spend accordingly.
The complication comes in later if that retailer goes out of business. Suddenly you're out the money and the item gets delivered to an entity that no longer exists.. and then goes to a liquidation auction getting sold for a fraction of the price to clear the retailer's debts. (Technically, you'd be on that list but so far down it doesn't matter.)
This isn't hypothetical either. If you know where to look, you can get some AMAZING deals right now.
In particular the impact of Fed QE policies on these rates is sufficient that I would not trust them to tell a comparable story now to what they did before QE started in 2009.
Poof. There goes (I'm guessing) $2K of window demand.
If you look at per capita income from 2019 to 2020 it actually went down. BUT we only really have 2 data points right now(2019 and 2020) so I don't think we will see a full picture until 2024 or 2025.
Personal data point, but psychologically I am definitely cutting spending on things like restaurants and groceries. I can afford that fast food meal for 20$, but I don't value it at that price, so I just don't buy it. I'm not really crying 'boo hoo inflation', I just kind of pass on it and go on about life.
Source: https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?end=2020...
I am trying to flip this to a positive with eating less in general and eating less meat.
This is called second round effect and it will come later, when people will spend and demand wage raises no matter what actual inflation rate would be then...
This is excatly what central banks are trying to avoid by cooling economy before inflation expectations got anchored and lead to inflaton spiral (in economic lingo)
Many medical tests are 99%+ accurate, but the false positive rate, meaning the probability that you don't have the disease given a false positive test is still extremely high. Like 90%+. Bayes law fucks us all.
https://math.hmc.edu/funfacts/medical-tests-and-bayes-theore...
I have myself tested positive twice without actually being positive when being deployed with the army, so agree on all your points that this is not great and not an intended goal,. Just what we get when we try to make the cheapest possible test today.
Probability of recession ('how often do you check?' question aside) is fairly low. If you can guess what specific number comes up on a dice roll 50% of the time, you're good at predicting dice rolls.
No.
Intuition: predicting the outcome of a coin flip correctly 50% of the time is unimpressive, but predicting the outcome of a D20 dice roll correctly 50% of the time is incredibly impressive.
Recession or not is binary, but that doesn't mean we have a 50% chance of entering one on a given day.
That doesn't include false negatives of course. Actuals vs positive predictions tells you nothing interesting.
If recessions happened every other financial quarter then the outcome would be binary. But historically recessions not that common; they happen in less than 1 in 20 financial quarters. So the D20 analogy is actually something of an understatement.
So it’s like predicting that you’ll roll a 1 on a die. Flipping a coin for your prediction would say you’ll roll the 1 50% of the time, which is obviously wrong.
You can get very high accuracy (more like 95%) by predicting that there will not be a recession because recessions are less common than expansions.
An indicator that flashes occasionally but it even if it wrong half of the time (you do the coin flip after the warning) it is giving useful information about an unusual event.
So when you combine a 5/12 accuracy indicator with a play that is low probability, little fee to entry, but huge reward you have a decent strategy.
if you throw a coin every day, and it's 50% accurate in predicting recessions that only happen every few years, that's a hell of a signal.
I think recession definitely falls under this category. And calling out a recession while we are already in it is not really a prediction.
Such as? We seem to be pulling all possible levers and are still barreling into a recession at full speed.
If we wanted to avoid this recession we would reduce the loan rate and increase the money supply. Not saying that would be smart.
The Fed is pulling fairly hard (but far from maximally hard, because there is considerable concern about policy overshoot) on the anti-inflation monetary policy levers. Those are also the ones that cause, rather than fight, recessions. They are doing this because pulling hard on the anti-recession levers due to the hard and fast COVID recession lead to an equally hard and fast rebound with skyrocketing inflation.
Congress is basically sitting on its hands on major fiscal policy levers, having returned to a basic neutral stance after fairly heavy anti-recession stimulus during the COVID recession. (If we really wanted to manage inflation while avoiding recession, we’d probably want Congress taking more targeted anti-inflation fiscal action aimed at the specific sectors driving overall inflation, so that the Fed could take a lighter hand on broad-focus anti-stimulative measures; if we just wanted to avoid recession in the near term period, we’d focus on stimulus and damn the torpedoes of inflation; but I don't think that would be wise.)
We are very, very far from pulling all possible levers to prevent a recession.
Without recessions credit risk becomes meaningless and is never tested - everything is endlessly going up so there is no leverage risk. People take on progressively riskier bets, zombie companies survive on loans, asset prices increase beyond reason because "you can't lose".
The system is incapable of monotonic growth and market intervention to take the sting out of recessions means the trees burn down not just the underbrush.
Clearly the last years have shown that low rates, tax cuts and helicopter money does at least postpone recessions.
Bush fires happening in forests throughout history happened due to lighting strikes and what have you, at least before modern times. Random natural events. Economic activity is a considered, thought out socialized activity - the central societal activity.
You're advocating the necessity of unnecessary problems due to other unnecessary problems - recessions are needed due to market inefficiencies, misallocated capital (cryptocurrency companies?), risky credit, leverage risk, riskier bets, zombie companies survive on loans, asset prices increase beyond reason, and a system incapable of monotonous growth. Your cure for this is all the maladies of a recession - higher unemployment, GDP actually shrinking etc. You list out many of the maladies of the current state of the relations of production and your solution is more maladies. This thinking is at best insular, unimaginative, limited and provincial. It is only tautological within a very limited view, where your solution for all the maladies you list out is self inflicting the malady of negative GDP growth and the maladies surrounding that.
We have nothing that didn't exist in 2001 or 2008 or 2020.
It is kind of weird to see Millennials whose economic awareness starts roughly in 2008 think that economics is fundamentally different now than it was 20 years ago.
There is something fundamentally different now than 2009-2020 -- but it is that the Boomers are retiring, COVID took people out of the workforce, and reduced immigration means that there's now fewer job seekers than jobs. This is causing sticky wage increases that have policymakers worried. They want to keep workers in check and contain wage inflation, so will throw on the brakes. The levers that they have are crude and the only real way to do this is to create pain which drops the number of job openings.
The current commodities inflation surge isn't even that out of line with the past. We had higher oil prices in 2008 before the bust, we also had similar prices, particularly on an inflation-adjusted basis in 2014 at the height of the last commodities boom (which did not end with a recession). And the current commodities boom is clearly associated with the pandemic. Two years ago we had negative oil prices. It is wild to see all the people in this thread not understanding the cyclical nature of commodities prices and the very clear bullwhip effects that are unfolding right now.
I've been predicting that since everyone expects inflation that just on contrarian logic alone the bulk of the people have to be wrong and that we're due for a strong recessionary crash / depression. That logic seems to keep on getting better. The fact that people believe the Fed can land the economy softly, without a recession, and get inflation under control is also pretty wild though.
Anyway, can they feed fight inflation and avoid a recession? Who knows but it seems if they have to choose they are choosing a recession. A string crash/recession definitely seems like a real possibility.
Anyway, preventing and postponing both messes with predictions.
Even if you did have hypothetical tools to do so, how would you know you prevented one anyways?
Can recessions be prevented. I think it is believed they can. The theory is juice the economy on hard times and pump the brakes in good times. This the depends on two things, ability to know what is good and bad times which I personally depends to some extent on predicting the future. I think it also depends on being able to use the brakes in good times which we did not do, the Trump tax cuts clearly should not have happened if this was the goal.
So even though I believe in the Keynesian model I agree with you that it might not work in practice. But it is mostly working right now, although clearly not 100%.
But I think the evidence is quite clear that the timing and severity of a recession can be influenced by monetary policy, and if you agree with that you probably agree that predictions of recession are not going to work 100% even if there was a clear way of predicting them.
“It is believed they can”…by who? Other than you of course.
The severity of a recession is determined by what is done in the early days of the recession, not before.
That is not the classic joke.
First off, inverted yield curves has accurately predicted recessions without false positives. Look up Campbell R. Harvey, who first published on this phenomenon in his dissertation:
* https://today.duke.edu/2019/07/its-official-yield-curve-trig...
Interview from 2019:
* https://www.youtube.com/watch?v=9sb1byR8Zx0
Its record is 7 for 7, with no false signals, using data since 1950. Of course people weren't looking at it closely until post-2008, so now it could (as mentioned in the interview @4m50s) become part of a feedback mechanism.
Second, the actual joke by economist Paul Samuelson (who wrote "the" textbook on economics) was about Wall Street:
> To prove that Wall Street is an early omen of movements still to come in GNP, commentators quote economic studies alleging that market downturns predicted four out of the last five recessions. That is an understatement. Wall Street indexes predicted nine out of the last five recessions! And its mistakes were beauties.[18]
* https://en.wikipedia.org/wiki/Paul_Samuelson#Aphorisms_and_q...
That market consensus captures a lot of information and boils it down to its essence.
Politicians appease the rich to keep the economy afloat. That's how it's always worked throughout history, that's how it works now, but I would argue that it must not be allowed to continue working that way in the future. Unless we want to keep waiting for a handout from the rich under trickle-down economics.
The solution to all of this of course is to examine the opposite choices that were available to us at any point in the last 40+ years. Some low-hanging fruit is stuff like Who Killed the Electric Car, or when Bill Clinton caved to Newt Gingrich and dismantled social programs and let the The Gramm–Leach–Bliley Act happen which created/exacerbated these 10 years boom-bust cycles, or when Ronald Reagan took Jimmy Carter's solar panels off the white house and set renewable energy in the US back 30+ years, or when we kept Cold War military spending levels after the Berlin Wall fell in 1989, just on and on and on and on and on. An infinitude of unforced errors which ran up a bill that Gen X and younger now has to pay.
That was a bit of a rant sorry, but I almost can't believe we're talking about yield curves when a modest 3 bedroom home costs half a million dollars and working people are making $15/hr if they're lucky. If I were a young person today listening to an older person gaslight me that nobody wants to work, I mean, I don't see how I could do anything but laugh at them. Just outright laugh at that level of cognitive dissonance.
Markets cost of money is shaping the economy more then the other way around. (Well, almost but there is enough of feedback loops)
It’s a fundamental component of the global economy. It is in the “ground truth” for market demand and supply for cash flows across time horizons, at a point in time.
Or you can just look at the entire curve, which subsumes all the information in the OP link and in the fedwatch tool: http://www.worldgovernmentbonds.com/country/united-states/
In particular there is basically no yield spread left between the 2y and 10y.
More immediately to this thread - the 3m yield will most likely soon become what is currently the 1-2yr yield, and that without changes in the 10yr yield will close the 3m 10y spread.
So now we approach a point where tightening has to happen because both the Federal Reserve and U.S. Govt have run up the balance sheets and debts to very high insane levels not meant for "peace time".
Now as they attempt to roll it back, certain issues start to appear. First due to lots of factors... main one likely being generational bretton woods style changes to the global economy and the reserve currency used. The only argument against this is that China, Russia and maybe most of OPEC moving away from using dollars to handle various transactions tends to cause certain unexpected issues while that is happening. One of those is inflation since for mant years it has been one of the United States main exports...
So while all of this is rolled back or changed, it reveals all of the existing structural problems that were never really addressed...
All of these factors either mean a big crash or a controlled demolition of the whole QE system and a global reordering of trade.
There are far too many factors to control and many more are not controllable. So expect a crash.
To determine when this is likely, maybe watch the repo and reverse repo market rates. Since 2020 they have increased steadily, now in trillions of overnight funding needed, and continuing to grow. This could quickly lead to something not often discussed where the Federal Reserve loses the ability to control interest rates. It is kind of a paradox, balance sheet growth -> liquidity -> inflation -> higher borrowing costs -> more balance sheet growth.. This process cant go on forever... Many metrics exist to watch it but the idea that the Govt will one day say OK we cant fund repos tonight, everything financially will be locked up by morning... like 2008 but worse..
That Paul Volcker guy had a lot of good ideas that they tried and failed to implement since 2008. Maybe those will deserve a second look, once all of this is over. Point being, nothing was fixed since the 2008 crash and as soon as the free money runs out, it will be obvious.
Also, inflation kills democracies more often than anything else.
May you live in interesting times.