(It`s different this time (Revisited

The yield curve has been inverted for some time now, but its the momentary inversion between the 10 and 2 year bonds that got investors freaked out. It also unearthed the old choir of those saying its different this time.

Lets take a look at what some people are saying this time and at what people had said in the past, we will start with the present:

"Tom Porcelli, chief U.S. economist at RBC Capital Markets, highlights how this instance is different from past yield curve inversions. In the past, the curve was a gauge of U.S. economic growth, but these days it is being driven by what’s happening around the world."

"Jay Bryson, acting chief economist at Wells Fargo Securities, argues that the 10-year yield would be much higher without the Fed’s bond buying."

"Jennifer Hutchins, Portfolio Manager at 1st Global in Dallas, Texas, says, “The yield curve inverted in February 2006, well before the down market swing in October 2007. If investors had pulled out of the market in February 2006, they would have missed out on approximately a 12% gain posted by the S&P 500 over the next 12 months"

If you think these are low profile names for the quotes above, here is one from former FED chairwoman Janet Yellen :

“Historically, [the yield curve inversion] has been a pretty good signal of recession and I think that’s when markets pay attention to it but I would really urge that on this occasion it may be a less good signal”

One from Allianz chief economic adviser and Pimco’s former CEO Mohamed El-Erian:

"The inverted yield curve recession signal that made all the headlines this week might not be as reliable as it has been in the past"

And one from JP MORGAN :

“ investors would be wise to remember that the yield curve is not an infallible indicator. This most recent inversion comes roughly a decade into a period of unprecedented unorthodox monetary policy, with zero or negative interest rates and bloated central bank balance sheets around the developed world. With very little of today’s bond market resembling the bond market of the past, it stands to reason that the yield curve may be a less reliable barometer of economic health.”

There are many more, but the messages tends to repeat themselves –  here they are summed up:

The yield curve is distorted because of the FED.

The yield curve is distorted because of the global economy.

The yield curve is distorted because "HEY LOOK, A BIRD!"

The yield curve is inverted BUT there is enough time until a recession hits, we can make money until then.

Lets travel back in time to 2005-2006 and visit some of the things people said back than, just after the yield curve has inverted and just before the onset of the Global financial Crisis:

"ALAN GREENSPAN, the Federal Reserve chairman, raised more than a few eyebrows in November when he said in testimony before the Joint Economic Committee of Congress that there was no need to worry that the yield curve had flattened and was close to inverting. The yield curve, he said, has lost its ability to forecast recessions."

"there are always exceptions to the rule, said Stuart Schweitzer, global market strategist at JPMorgan Asset Management. In the past, whenever the yield curve inverted and a recession followed, both short-term rates and long-term rates were on the rise.This time, short-term interest rates have been climbing gradually while long-term rates have remained fairly flat"

"Federal Reserve Chairman Ben Bernanke said the prolonged inversion of the U.S. Treasury debt yield curve does not signal a slowing economy, but it could pressure profits at smaller banks. There’s been a good bit of evidence that the declines in the term premium and perhaps a great deal of saving chasing a limited number of investment opportunities around the world have led to a somewhat permanent flattening or even inversion of the yield curve, and that pattern does not necessarily predict a slowing in the economy or recession"

Humans are incredibly talented in shaping the evidence coming to them from the outside world to agree with their views and  beliefs, some of the reasons given by people against the inversion forecasting ability were actually the same reasons that caused the flowing crisis:

"People have been watching the yield curve for quite a while and have baked in the possibility of an inversion," said David Easthope, analyst at Celent LLC, an independent research and consulting firm. "I don't get the sense that there is any panic because firms have learned a lot since 2000 about being prudent."

"Spikes in foreign investments and an increase in investments in derivatives and hedge funds are helping to stabilize the economy. Rates are low and attractive relative to rates around the world says Margo L. Cook, CFA, managing director and head of institutional fixed income management for BNY Asset Management"

"Valuations are not as extended as they were back in the late 90s. Interest rates are lower, and we don't have the market euphoria," says Henry Chip Dickson, CFA, chief U.S. strategist and associate director of equity research for Lehman Brothers … In his strategy report, Dickson noted that the yield curve inversion in general has lost some of its predictive power since the 1970s because "we have a more global economy that's tied more to financials, and derivatives are more important."

"With the benefit of hindsight, we now recognize that an important change occurred in the U.S. economy (and, indeed, in other major industrial economies as well) sometime in the mid-1980s. Since that time, the volatilities of both real GDP growth and inflation have declined significantly, a phenomenon that economists have dubbed the "Great Moderation." I have argued elsewhere that improved monetary policies, which stabilized inflation and better anchored inflation expectations, are an important reason for this positive development; no doubt, structural changes in the economy such as deregulation, improved inventory control methods, and better risk-sharing in financial markets also contributed. (Ben S. Bernanke)

Now, no one can see the future, i certainty cant. This is why it is so easy for people to say it might be different this time – No one can actually know, it just might be. But the yield curve inversion is such a formidable indicator that the occurrence of an inversion should serve as an opportunity to practice risk management rather then to try and find reasons for why it might be broken this time.

 

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