Ringing a (Tiny) Bell

June 30, 2019

Early in June the current 3-month/10-year Treasury inversion got a lot of attention.

I opined at the time that 10 BPs wasn’t very much, and I wanted to see it persist or widen before calling it a signal. It did that, lasting through the entire month.

First, let me be clear about what it actually tells us. The investors in Treasuries are the most risk-averse US Dollar investors around. There are just over $60 billion of the current 10-year Note, and $35 billion of the current 3-month Bill. Investors in the 10-year Note are totally aware that they can get 2.15% by investing in the Bill, but they are choosing a 2% return instead to avoid having to reinvest in three months.

Why it is a signal:

When serious investors don’t like the prospect for the next few months or year (in terms of reinvestment options at that time), they are choosing to avoid having to make that decision when they tie up their money for 10 years. If they are right, that investment opportunities are going to really suck in the near future, that would be because they think riskless returns are going to be even lower, and they also think returns on risk assets have a high probability of being negative if you buy into them in that time window.

As Larry Kudlow was fond of pointing out before he got his current gig, the 3-month/10-year curve inversion has an amazing track record — seven for seven in modern times. NBER usually lags reality by two or more quarters when it comes to declaring official recessions, so don’t expect to see “we are in a recession” headlines six or twelve months from now. More likely is that, 19 or 20 months from now we will get the “news” that we have had one.

On the bright side, deficit government spending, especially in military and security, is going up at a pretty good clip, and that adds to¬†GDP, though not with the multiplier effect of other kinds of government spending. And there’s the stock market if you want to be in the “don’t worry, be happy” camp.