What is the Yield Curve, and is it Predicting a Recession? // inverted flattened explained bonds David Moadel
welcome to looking at the markets with David Modell today I wanted to talk to
you about the yield curve what is the bond yield curve why is it important to
know about it can it predict a market crash or economic recession and where do
we stand now with the yield curve all right so yield curve what is it it's
also called the term spread it is the difference between long term bond yields
and short term bond yields specifically it usually refers to the 10-year bond
yield minus the two-year bond yield in a fairly normal and healthy economic
situation 10-year bond yields should pay more than two-year bond yields after all
a 10-year commitment should yield more or pay more than just a two-year
commitment that makes sense also if strong economic growth is
expected in the coming years then higher inflation is to be expected because
prices will rise therefore the 10-year bonds ought to have a higher yield they
ought to pay more in order to compensate for the expected inflation but when the
market doesn't expect the economy to do well and doesn't expect inflation to
increase ten-year bond yields can remain stubbornly low like they are right now
meanwhile if the Federal Reserve keeps on raising short-term bond yields which
they've been doing there can be a narrowing between the ten-year and the
2-year bond yields they can get closer together the next thing you know we can
find ourselves in a bizarre situation in which 10-year and two year bond yields
are the same this is known as a flattened yield curve so when the two
year when the ten-year and two year bonds paid the same amount the same
percentages that's a flattened yield curve then it
can get even more bizarre we can have a situation in which two year bond yields
are even higher or greater than 10 year bond yields and
this is known as an inverted yield curve so let's take a look and I want to give
credit for this graphic here it's from bankrate.com alright so here are some
examples of your yield curves all right so this is a normal one the the light
blue line alright so let's take a look at the two year if the two year Treasury
notes or bonds US government bonds yield if the two year ones yield this much and
the ten year ones yield this much which is much higher well that's normal the
ten year ones should yield a lot more than the two year ones all right that
makes sense so that's a normal yield curve it should go upwards at a normal
pace sometimes you'll get a steeply sloped yield curve you don't want it to
be too steep but this can happen but it gets bizarre when the line flattens out
like the red one here when the two year bonds pay just as much as the 10-year
bonds that's not how it should be it just doesn't make sense and then when
the yield curve like the green line here actually inverts then you've got the two
year bonds paying even more than the ten year and twenty year and thirty years
sometimes even when the two year bonds pay more than the ten year bonds that's
very strange and it should not be like that it's not a good sign in most cases
think about how strange it is for a short term bond to pay more than a long
term bond it doesn't really make sense and it shouldn't be like that but it's
more than just strange it's also surprisingly accurate it's a
surprisingly accurate predictor of economic recessions talking about
inverted yield curves are an accurate at least in the past they've been an
accurate predictor of economic recessions at least according to the San
Francisco fed let's see what they have to say about it
the term spread or the difference between long term and short
interest rates is a strikingly accurate predictor of future economic activity
every u.s. recession in the past 60 years was preceded by a negative term
spread or in other words an inverted yield curve furthermore a negative term
spread was always followed by an economic slowdown and except for one
time one exception was followed by a recession let's see what that looks like
and this is also from the from the Fed same source the San Francisco fed
Federal Reserve let's take a look at that so the gray bars here gray columns
are recessions throughout the years in the United States and this blue line
represents the difference in percentage points between the ten-year and the
2-year bond yields and we can see when it dips when it gets down to zero it's a
flattened yield curve which is strange and then when you get below when it gets
in a negative territory then it's the really strange situation of the inverted
yield curve it happened here and right after that recession happened here
recession right after here's the exception they were referring to it
happened here no recession now this was many years ago so yes there was an
exception a long long time ago but look at right after that it went into
negative territory recession right afterwards negative recession negative
here's a recession soon after negative again and recession negative recession
negative recession negative recession and here's where we're heading now and
it's getting to axe actually the blue line is right now closer as of this
video the recording this blue line is very very close to flat and negative and
I'll show you that momentarily so here we are where are we now again we can
look to the sand Cisco fed for our data and here's where
we are right here this is zero underneath is negative and look how far
look how close we've gotten to zero to flattened and inverted currently as of
July - July 23rd 2018 which is when I'm making this video the difference between
the ten year and two year bond yields is a mere point 29% almost at the point of
becoming flattened or inverted so what's my point well if you're 100 percent long
US equities stocks in other words you might consider lightening up your
position and allocating some capital towards precious metals and other
commodities currencies crypto currencies and/or other holdings that are not
strongly correlated to the equities markets in other words I definitely hope
you're protecting your assets I hope this makes you think I'm here to make
you think you have to make your own decisions I know what I'm doing do you
know what you're doing my name is David Modell this is looking at the markets if
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alright thanks a lot I appreciate it please take this warning to heart it's
important all right I'll talk to you again soon
thanks a lot