The Yield Curve

Hey everyone and thanks for jumping back Into the macroverse today we're going to Talk about the treasury yield curve and How it can be useful in understanding The health of the US economy if you guys Like the content make sure you subscribe To the channel give the video a thumbs Up and check out into the cryptographers Premium at into the we Do have several different tiers Available make sure you check that out Including a free one let's go ahead and Jump in so the last time that we talked About the treasury yield curve or at Least I should say the last time we did A full dedicated video on it was I Believe about three months ago now we Have spoken about it since then of Course we talk about it somewhat Frequently frequently in the context of Of other macro indicators that we're Looking at and so we will frequently Bring it up but the last time we did I Believe a full dedicated video on it was About three months ago and you can see Here right it was you know sometime in Mid-october So the reason why I want to provide an Update is because it's already starting To look quite a bit different today than It did back then all right so today You'll notice that the short end of the Curve has risen a lot with relative to The long end of the curve so you know

Back in October the one month was well Below you know the the three year and The five year and the Seven you know and So on and so forth and so was so too was You know the three-month Um and the two month Etc only a few of These ones say like the six month and The one year were more elevated than Some of the longer term ones so today Though you see it is a bit different What do you notice about it today the Short end of the curve is actually much Higher than the long end of the curve Right so the short end of the curve is Much more dependent on you know what the Federal Reserve is doing here in the Short term right so you know if if the FED funds rate Is around four and a half percent then You're gonna see the short end of the Curve somewhere around that level Because you know like the it's not that Hard to imagine what their policy is Going to be a few months from now Whereas Five years from now or ten years from Now is obviously a different story right There's going to be a lot more Complexity related to that now what You'll notice is that again the Shortened the Curve Is almost it's almost fully inverted now Right I mean you're you're looking at an Almost fully inverted yield curve and

All you'd really need to see is for you Know the the short end over here the one Month the two month and the three month To rise above the six months you're Essentially looking at a fully inverted Yield fairly fully inverted curve with The exception maybe the 20 and 30 year Here at the very end but the reason why This is important if you think about This from a fundamental perspective Right if you're putting your money in a Bank and say like uh Um you know like a CD or something You're locking it up for a while you Would expect in general right if the Economy is is healthy you would expect To get a higher yield for holding it in That account for longer periods of time Right at least when you apy right when You annualize it so you would expect That you know if you're going to put Your money in a bank and you're going to Leave it there for three years it would Make sense that you would get more Annualized than you would if you were Only doing it for three months right it Makes sense Um you know you're essentially taking on More Risk by by locking it up for a Longer period of time because you're Missing out on on potential other Opportunities that the the market might Offer but when you see an inverted yield Curve like this it historically has a

Has been a fairly good predictor of or At least saying you know what the Economy is is somewhat sick and it's Going to take a while for you know for It to get better so what I want to do Here to begin with is I'm going to play The the um the evolution of the yield Curve starting from the 1990s okay so We're just going to hit play And what you'll see is you know here This is what it normally looks like Right you would normally expect to see Like this now we're coming up on the 2001 recession so look what happened Right it inverted now we're coming up on The 2007 recession right the financial Crisis right the inversion and then you Come out of it and then this is what it Looked like during basically a decade of Economic expansion fairly normal yield Curve coming up on the 2020 recession Very brief you could see it fully invert Or it briefly inverted and then now this Is where we are again So scroll it back through time right if You look just before the financial Crisis you'll see that it was inverted You look back to the or sorry this is crash right you look back to the Financial crisis you'll see the Inversion of the yield curve right Same thing right with with uh what Happened in 2020 at least to some extent I mean that was sort of a a crazy time

Because everything happened so quickly Right and so it took a lot it took was It you know everything was sort of Adjusting quite quickly because policy Was kind of all over the place and what Was a lot of uncertainty at the time But look at it where it is today right So what does this mean you know and and One of the things that we've talked About before is that the inversion of The yield curve Does not mean you're in a recession Right it does not mean that it Historically has not meant that right You take a look at at Treasure yield Spreads When you be when the yield curve inverts Right or at least if you say look at the Spread on the tenure in the three months When it when it inverts are you in a Recession typically no you're not right Plenty of times where when it inverts You don't find we don't find ourselves In a recession so the inversion of the Yield curve in and of itself is not a Predictor of a recession or it's not a Predictor that we're in a recession it's A predictor that by the time it all Resolves itself we'll likely find Ourselves in one right but here's the Problem like here's the thing that I I Think a lot of people need to need to Remember about this is that It can take a long time right it can

Take a long time to actually see it Fully play out and you know if you Looked at the spread on the two-year and The 10 and the ten year the average lag I think on it from a sustained inversion So let's say for three months or so is Like almost eight it's like 17 months I Think right or something like that Around a year and a half the average Time Now you could find periods that are less Than that right and you can find periods That are longer than that but on average It takes about 17 months or so from the sustained Inversion of the yield curve And let's call sustained inversion about Three months being inverted from that Point before you actually find yourself In a recession so that means that If the United States experiences a Recession it might not be until another Half year or another year potentially Right Now I mean it of course it could come at Any time but that's the you know that's The thing that you have to remember and That's one of the reasons why why you Know the yield curve is an important Tool I think to sort of show you where The healthy of the where the healthy the Economy is but it's not necessarily the Most helpful tool in telling you you Know exactly when the recession is going

To come it tells you that one is likely Coming at some point in the nebulous Future but again A lot can happen in Markets between now and then right and This is something we've talked about for A while is how the lag time on some of These indicators can be a year a year And a half sometimes even longer okay I Mean there's been periods where it can Take you know over two years before you Actually get something like that so that Is is something that you have to keep in Mind now when you look at the three Month and the ten year this is a Question I've been getting quite Frequently so I wanted to address it A lot of people have looked at this and Said well this seems somewhat crazy the Treasury will spread here Is deeper Inverted than it you know I mean at Least then it has been at least the data We have on the website I mean going all The way back to the 1980s it's more Inverted than any time in the last 40 Years Okay so what does that mean well In you sort of what I've looked at there Really is not a correlation between the Depth of the inversion and and how bad The recession will be so and that might Come as a surprise to some people right You might look at this and say well the Deeper the inversion the worse the worse

It has to be that's not actually true Okay if you look back throughout all of History there's not really a clear Correlation that I could find between The inversion the the the depth which it Inverts versus the severity of the Recession okay So again this might come as a surprise But if you're looking at this and and You see it and you know you see it all The way down here And you know at negative 1.24 versus Where it was back say before the Financial crisis you might look at that And say wow it's like twice as bad Doesn't it does not mean the same thing Like it does not mean it's going to have To be twice as bad right it simply does Not mean that Um looking back throughout time so I Would say again When it resolves to the upside whenever That occurs whether it's next quarter Through you know two quarters from now The end of the year next year it Typically means you get a recession but It does not mean you're in one typically During the you know during the at least The initial phase of the inversion right Going into the inversion of the yield Curve you really don't find yourself in A recession in fact if you look closely What you'll notice is that typically When it inverts the market can still go

Higher and put in new highs this is not That uncommon for the market to do I Mean look what happened over here when It inverted you know back in July of 06 It did not stop the market from rallying For another year or more before it Finally came out of it and we Experienced the recession Now What is interesting about this time Versus the other times right and you Know at the risk of of saying something Is different right in the sort of the The cliche that that has become One thing that I I do think is at least Worthwhile to point out is the interest Rate hikes and the the speed of them Okay so if you were to go take a look at The effect of federal funds rate what You'll notice and if you really you know Hone in here to Um you know the last like 30 years or so Normally the FED is Raising interest Rates when the market is pretty strong And and moving along pretty well Um not really doing periods of high Inflation right where this was not During a period of high inflation uh in The 90s was not really doing a period of High inflation can the interest rate The effect of effective federal funds Rate was going up Over here in you know 2000 and like 99 And 2000 the market was still pressing

The new highs and then once the market Rolled over that was when the FED cut Okay raising interest rates quickly over Here in you know 2004 2005 2006 and then A pause Throughout 2000 and through a lot of 2007 and then the minute the market you Know the minute the economy showed Weakness the FED caved and then they They quickly cut right so what's going On this time and then maybe one more Comparison is you know going into what Happened and you know we had we saw a Rising interest rates in 2016 2017 2018 2019 again during a period when the Economy was pretty strong Market was Going higher And then they quickly cut right very Very quickly as as the you know the Economy started to show signs of Weakness So then what's going on today right I Mean like you know It looks Very dissimilar from at least the last Few right this time the FED is raising Rates And the market is going down right so I Mean it is very different from what we Saw during the previous rate hikes Because you know at least during the Last three rate hiking Cycles by the Federal Reserve the market was trending Higher not lower

Again why are they doing this well again We know why it's because inflation's High so they feel compelled to you know To be hawkish even despite the fact that The economy is is you know is is saying Hey things kind of are not so great why Are you doing this will the fed's saying Well we have to inflation's high it's Part of our mandate Um so this is you know this is an Important Nuance I think of this cycle Is the fed and this kind of goes back to 2022 when you essentially had Effectively everyone collectively saying That the FED will never go above three And a half percent or they'll never go About a couple percent or people saying They'll never raise by more than 25 Basis points and the reason they said That Is is I mean it's not that It's not that absurd I think for them to Have said it it's just that Everything that they've probably known For the last 10 or 20 years has been That right it's always been well the Fed's only going to raise by very small Amounts and the minute everything starts To look bad they're going to cut why Should why why did a lot of people think That last year because that's what they Always did right that's what the FED Always did but again in order to Understand what the FED does you have to

Look at similar periods right and to Find a similar period as to what we're Going through today at least you'd have To go back to the 1970s right find peer Of high inflation or the early 1980s You'd at least have to look back then Where the Fed was much more aggressive With interest rate hikes than they ever Were In the last 20 to 30 years so you know It's a mistake to look back at the last Few business cycles and say well because The FED did this during those times it Means they're going to do it this time You have to look for similar conditions Right and similar conditions involve you Know looking at things like periods of High inflation okay So then going back to the yield curve Right so going back to the yield curve It's almost fully inverted Once it uninverts That's when the recession typically Comes right Look at the treasury old spreads again Only three year the three month and the Tenure it's when it uninverts That it occurs Nowhere close to uninverting right now Right so again Historically what this indicator shows Is that it's not a predictor that we're In a recession during the inversion part Right it's not it's a predictor that one

Will likely occur at some point before This you know before this cycle is is All done with and we start a new one Right before we get into another phase Of of of true economic expansion you Will probably need to see the resolution Of this and when you get that resolution It it I mean what it has historically Meant is is a recession it can be a very Short one it can be shallow it can be Deep a long recession it all depends on On how much damage the Federal Reserve That the Federal Reserve does to the Economy Not only via higher interest rates but Also through quantitative tightening Like you know rolling off assets from The balance sheet and and draining Liquidity from the system right so you First start off with essentially a Liquidity crisis I mean it's basically What it is right I mean it's what we had In 2022 where they're just draining Liquidity so you have like a liquidity Crisis where it's like well Hey where's All the liquidity why is the liquidity Going away well cat you know money's not As cheap as it once was because interest Rates are higher right and you know I Mean they also the FED also seems pretty Determined to make the unemployment rate Go up so I mean that's just going to Create a lot of hardships for people and If that's the case it's usually not that

Kind to to to equities as we've as we've Seen in the past so Um I would keep a close eye on on this uh On the yield curve and and again you Know just to remind you the depth of the Inversion is not necessarily indicative Of how severe the recession has to be Okay it's not Um and again the two year and the ten Year is actually you know not as Inverted compared to where it was Actually in the 1980s and you can see it Had pretty deep inversions back over Here if you look at the three month and The ten year Um going back to at least what I have Data for here on the website you can see That it's more inverted than it has been At least since you know 1982. Why is it more inverted this time Because this rate hiking cycle by the FED is is essentially like nothing we've Ever seen I mean the the the pace at Which they've gone is is Not something that is is very common Um and and so I mean that's one of the One of the reasons I I think you you see It like this and what's also interesting Is how a lot of Market participants Throughout 2022 just simply did not Believe the FED that they were going to Actually raise rates this much and Arguably I I do think that investors are

Are you know more aligned with what the Fed's actually going to do But there are a lot of investors that You know that are that are pricing in Um cuts by the Federal Reserve this year And while it could happen I I think the Earliest it could happen would be the End of this year and and there's Actually a high chance that they don't Cut until next year I mean they've been Fairly clear about that and I know a lot Of people say well why should you trust What they say I mean if you trusted what They said last year in 2022 you would Have just been risk off right and and Cash is King and and all that sort of Stuff right because hey if they're going To keep raising by 75 basis points and And get us to a pretty high terminal Rate That's just the the the the the harsh Reality of of a hawkish Federal Reserve So again fighting the FED last year it Did not work right it did not work at All and and so we have to we have to Keep that in mind so again you know just To sort of finalize here looking at the Treasury yield curve it's almost fully Inverted and I just want to again draw Your attention to what it looked like The last time we did a dedicated video On it uh you can see where it was and And how quickly just over the span of The last three months how quickly the

Short end of the Curve Is now all the way up here with respect To the long end of the curve okay And so At some point this will resolve but I I Want to remind people it can take Another three months it could take six Months it could take a year so again you Need to be you know you need to remember That as an investor that just because it Looks like something is going to happen Does not mean it has to happen tomorrow And and as we've seen as we have seen The U.S economy has not wanted to go Down without a fight I mean look at the Unemployment rate it still is at a Secular low at three and a half percent That's the lowest it's been this Business cycle I mean you can see that's Where it was in July of 22 and also in September of 22 the U.S economy is Clearly not going down without a fight But the Federal Reserve also seems Determined to make this eventually go Higher above the you know well above the Or at least somewhat above the four four Percent level so this is something we Need to continue to watch if they are Successful in raising the unemployment Rate you can see that does tend to Correspond to recessions and and once You see a You know once you see that happen well What really will be interesting is the

Response by the Federal Reserve because So here's the thing that you have to Think about like as an investor you know You have two different things that the Fed's dealing with right you have Periodify inflation which is coming down Quickly which is a good thing but you Also have Um you know the unemployment rate which Hasn't really budged so here's the Potential issue what does the FED do if The unemployment rate Starts going up and inflation is still At four or five percent right what do They do I think the market would expect Them to go back to QE right and it's Almost like the market is thinking that They'll just start cutting rates Immediately whenever that happens I also think there's some evidence if You if you listen to what Powell says That they're really not going to go back To that until after they really see a Sustained path back to two percent I Don't even think getting you know Getting inflation back down to four or Five percent uh well I mean court if It's core I'd give you the less but if It's a three percent or four percent They still might want to see it Go lower Before they're willing to to actually Change their policy in any in any Substantial manner so Again that's something to think about

The the most ideal scenario of course Would just be that at least for you know For the US economy the most ideal Scenario would be that the Federal Reserve is able to accomplish their Mission of reducing inflation back down To their two percent Target without Affecting the unemployment rate in a Material way we are starting to see we Have been seeing for quite some time now The tech sector we've seen pretty Substantial layoffs right and you know We've seen 6 000 people laid off at you Know company a and then 12 000 at Company B again in the grand scheme of Things it's still a relatively small Amount of people within the context of The entire United States Workforce but Tech tech is going to get hit first Right and this is one of the first Things that's going to get hit why Because growth like like the Tech Industries like growth companies the way They grow so quickly is because they Have access to cheap Capital right and So by taking on that debt they can you Know they can really start to try to Grow quickly when interest rates go up The cash isn't as cheap so they're not Going to take on as much debt they're Not going to grow as quickly and so Because of that what's one of the ways That you reduce your cost as a tech Company what's one of the I mean it was

One of the quickest ways is just to lay People off because you're instantly not Having to spend that money on those Employees anymore I mean again it's a It's a brutal cycle but that's what Happens and so the argument of course is That If the Fed continues to do what they're Doing which it seems like exactly what They're going to do eventually this Effect will filter through to other Sectors and then when it does the Unemployment rate will go up and then it Will help reduce wage inflation which is What the FED is keeping an eye on and That will help CPI get back down to two Percent hopefully in a sustained way and Once that occurs we can ideally go back Into a period of economic expansion Right that's the idea Do we get a recession between now and Then that's up for you to decide right There's certainly there's a lot of Charts that suggest it's going to happen With that said there are a few charts a Few macro charts that still look pretty Strong again the unemployment rate is One of them there's still still a few Charts that say you know what we haven't Really seen the the the the US economy Screen that there's a lot of weakness Here yet and so of course there is still Some hope that the United States will Avoid a recession but that's what we're

Currently looking at hopefully talking About the yield curve Um you know at least every three months Or so a video on it is is helpful uh to People I I do understand that this this Content is not as exciting as as as some Of the content I could make but I would be remiss if if we didn't spend Time talking about this because see Here's the thing right like a lot of People would like for for this thing to Just get resolved and and for us to not Go into a recession and and while that Is always a possibility right certainly Anything's a possibility the problem is That it is really ignoring history right It really would be ignoring history to Say that it won't happen and so I do Think we need to be aware of that and The reason we all need to be aware of is Investors is because You know typically equities bottom During the recession right I mean that's Where we've historically seen the S P 500 bottom right it doesn't bottom Before it It bottoms during the recession right Historically or after right I mean I I Think if you look at like the last 10 Recessions we looked at all of them Bought them during the recession except For this one over here in 2000 which Bottomed after it so that's what history Tells us that's why we follow it could

Take six months 12 months to play out Who really knows but we will follow it Every few months and probably maybe just Provide an update on the yield curve uh Once a quarter I write like a dedicated Video on the yield curve once a quarter Well it will help keep us aware of What's actually going on here and and What is it telling us about the health Of the US economy if you guys like the Content make sure you subscribe give the Video a thumbs up and again we do have Into the Crypt diverse premium I don't Know the see you guys Next time bye


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