Death of the Yield Curve?

When Alan Greenspan ran rates to near zero in preparation for Y2K, he kicked off a wave of financial asset speculation.

Not satisfied with that object lesson, he repeated the monetary stimulus (doubled down) after the 9/11 attacks, thus making sure we could all go shopping whether we had the income to support the new debt or not.

As much as modern economic historians would like to blame the debt overhang problem on families or government, the reality is that debt growth from the late 90’s until the collapse of 2008 was by far fastest and largest among financial companies.  Luckily for them, their position as the dominant “industry” in the S&P 500 and their position as the largest contributor to both parties in the national government pretty much set us all up to be the life preservers for the banks and brokerages.

Unfortunately, when you’re just an ordinary Joe trying to swim to shore after the ship capsizes, you are likely to drown if you are being used as a life preserver by the 240 pound bankers.

All of which brings me to the actual difference this time that may allow the yield curve recession predictor to fail.

Ben Bernanke bought $3 trillion of US Government obligations after taking market interest rates to zero at the short end of the curve.  Throw in the over $14 trillion of US government guarantees that were put on everything from corporate commercial paper to reverse repurchase agreements to Agency MBS, and let’s not forget the global reaction to the crisis that led every major government (only Iceland said no) to guarantee the credit of its banks.  So much for the FDIC limit on insured deposits.  Every political system in every major economy somehow decided it was OK to ignore their laws, ignore their principles, and protect lenders from the risk they had taken.

It’s as if the team doctor had shot up the entire team with cortisone and methedrine, and put them back onto the field.  No wonder they managed to score a few points!

Now the ECB is about to buy all the Italian and Spanish bonds (and Greek and Irish is my bet) that the international banks can’t afford to hold or mark to market.  I can’t make up anything as crazy as this.  Maybe they will even call it the Troubled Asset Relief Program.  We never actually bought the subprime bonds, after all.  I figure we didn’t use the name TARP long enough to have a valid claim on it.

Our guys decided it would be more fun to just give the banks more capital at costs a fraction of the free market value, since that made sure the taxpayer was directly subsidizing the investors who owned the bank stocks and bonds.  They used a lousy three paragraphs in the monster bailout bill and ignored the rest.  Even better, those investors could still pretend they were “job creators” deserving of special treatment, deference and tax breaks.

So my question is this:

If the credit markets used to be able tell me what I needed to know about upcoming recessions and recoveries, maybe Ben Bernanke, and now Jean-Claude Trichet have messed up their predictive power by distorting the markets.

Disrupting the biggest capital market in the world used to be considered impossible – like King Canute commanding the tide to recede.  But what if King Canute had a giant siphon that could suck up half the ocean?  Bet he could make that tide turn on a dime.

For now, I’ll stick with history to guide my expectations.

But I will watch with interest to see if we can actually go into a recession with a steeply upward sloping Treasury yield curve.



3 Responses to Death of the Yield Curve?

  1. Taymere says:

    If Japan is a fitting example it may longer be predictive for America either

  2. Dan J. says:

    Howard, not sure I understand your thinking (wouldn’t be the first time, right?) We suffered through a recession, supposedly in 2008-2009, but the curve (2-10) was not inverted, but rather “grew” steeper. We did have an inverted curve, more or less, from about 2/06-5/07. Is that what you refer to, i.e. that the curve during that time forecasted our recession to come, or the curve DURING a recession is inverted. Love your blog.

    • hhill51 says:

      Hey, Dan…

      It’s the prediction that counts, and my version of the indicator adds in the BBB bond yield curve slope (steep) and spread trend (wider). Since you may be able to pull that info from the Bloomberg Pro, I’d love to see what they were in the runup to catastrophe that we saw in 2007. My guess is that the collapse of Carlyle and the Bear mortgage funds early in 07 were accompanied by general corporate spread widening and steepening.
      Recall that the NBER dates recessions from their beginning month to end month, and they do NOT use the cheesy “two quarters of GDP contraction” that lazy reporters still call the definition of a recession. That’s only a near-miss representation that usually accompanies an official one.
      In this case, I tend to watch the trend of corporate spreads as being just as important or more so, since that tells me when the market is predicting forward performance anxiety for BBB credits.
      Strangely enough, the steepening of the Treasury curve in 2008-09 could have also been warning us of future real default risk by Uncle Sam. I doubt the capital markets could have been predicting the magical thinking we saw last month, when elected officials responsible for policy (even one contender for the Presidential nomination) actually said in front of cameras that they thought deliberate default was a good idea that would help our country establish trust in its obligations.
      The Fed has always been able to manipulate the short end of the Treasury curve. What’s changed now is that they have shown they can do the same at the long end. On the other hand, they can’t change (as far as I know) what the market thinks of corporate ability to service debt.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: