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Bonds and Yield Curve – 13 to 15

by | Sep 16, 2019 | Bonds, Finance

Yield Curve – 13

The US and the Indian Yield curves are shown next to each other.

Now, this is not theoretical. These are the actual yield curves at the present time.

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You will notice that, unlike the Indian one, the US yield curve dips. It does not have an upward movement for the next 5 years or so. When the curve dips downwards, it is said that the Yield Curve has inverted. This is a very serious situation as far as a country’s financial future is concerned.

If the Yield Curve remains inverted for a quarter, ie. 3 months at a stretch, then the economy will go into a recession. This prediction has been proven true whenever the US has gone into recession since 1960 and more importantly, it has never given a false signal, means that it is has never happened that the Yield Curve has reversed for a quarter and the US has not gone into recession!

As of June 30, 2019, the US Yield Curve finished one quarter of being continuously inverted!

 

Yield Curve – 14

There were some questions after the last post.

The Yield Curve shows the yield that are currently available in the secondary market. It is not the rate at which the government sold those bonds. So, say a 10 year US treasury bond is available in the market for a 1.78% yield. It means that if you buy that bond now and hold it to maturity, you will get an interest of 1.78% per year.

However, if you buy the same bond after say 3 months, the yield will have changed, depending on the market conditions at that time.

Hope now you have been convinced that the US will be going into recession as per the signal from the Yield Curve. However, the curve does not predict after how much time the recession will strike. The average period has been around 15 months and the maximum is around 2 and a half years.

Now, when the US yield curve drops down (or inverts), are the bonds becoming stronger or weaker? Why? Is the economy becoming stronger or weaker? Why?

Until next time……

 

Yield Curve – 15

When the Yield Curve dips, the logical interpretation is as follows:

  • The interest earned on the bond is falling.
  • The cost of the bond is going up.
  • The bonds are in demand and people are buying them.
  • Investors prefer (in the US) to invest in bonds at 1.78% yield.
  • They don’t feel the stock market will give them higher returns.
  • When investor perceptions are negative, the market will drop.

However, there always is the ‘contrary’ argument. The most dangerous phrase of stock market investing is being heard often nowadays – “This time it is different!”

  • At no time in history, has the US fed pumped in so much money into the economy and kept interest rates so low. So, cheap money is available for investment and recession will be avoided.
  • My friend feels there won’t be a long recession, maybe a short-term dip. My opinion is based on learning and doing some financial courses. His is based on hands on experience – he trades in stocks in the stock market in the US.

So, if recession hits the stock market in the US, India will not be spared. What should one do?

In the last piece……

For previous posts in the series:
Yield Curve – 1 to 4
Yield Curve – 5 to 8
Yield Curve – 9 to 12
Yield Curve – 13 to 15

Niranjan Bangera

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Written By: niranjan

Financially Stupid Niranjan

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