Inverted Yield Curves
I had a reputation in high school of disputing the 3 points taken off on my geometry exam. Fast forward to my first part-time semester in pursuit of my UH MBA. As I recall, most non-BBA students had to take 12 prerequisite hours in graduate economics and QMS (basically, applied math like probability and statistics). The economics classes were non-trivial, and my macro professor had a strict grade quota system: in a class of 30 or more students, he would issue a maximum of 2 A's. (Now, to provide a context, when I was a UWM professor in the School of Business, we had a 2-C rule, meaning a third C or any lower grade would result in a degree disqualification.) On the mid-term I had written an imaginative response involving gold store transactions and the money supply, for which the professor had deducted partial credit. I saw him after class and paraphrased my argument, and I could literally see an "I get it!" light bulb flash across his face. He still refused to change the grade (not many professors will agree they made a mistake grading), but it was a moral victory.I recently read an investor newsletter recommend a particular bond transaction and decided to unpack it in more readable text:
More recently there's been a lot of discussion about inverted yields in the market. Here's the basic context: typically borrowing over a longer term of time requires a premium rate. Suppose I'm locked into a CD paying 3% over 5 years. In year 3, rates increase to 5%; I could be making 67% more with my money, but I can't, because my money is tied up in that CD. That's an opportunity cost to me. Now suppose I'm a bank in the business of taking cheap lower-rate money and lending it out at higher rates, making a profit off the spread. As the spread closes through some combination of higher costs and lower revenues, I can no longer make a profit. An inverted yield means that longer-term interest rates fall below short-term ones. Why might longer-term rates fall? Recession fears: interest rates should decline with less demand for loans. Investors should pay more for the same income stream, i.e., bond prices are inversely related to interest rates.
So inverse yield curves, hinting at recession, are intrinsically worrisome to the Fed. They have two basic tactics for trying to fight inverted yields: try to drive up long-term rates or drive down short-term rates, via bond transactions. Now it can drive up interest rates by selling bonds (supply/demand curves: more sellers, lower price, higher yield) or down by buying bonds (more buyers, higher price, lower yield).
An additional consideration: the money supply. Less liquidity tends to choke off economic growth. By selling bonds, the Fed accordingly shrinks the money supply; by buying bonds, the Fed increases the money supply. (There are risks to expanding the money supply, particularly inflation and malinvestment.)
So the investment newsletter suggests that a recession-averse Fed is likely going to fight by aggressively buying short-term bonds. True, short-term debt holders might earn lower interest, but they should also see their bond prices gain in value, offsetting losses in interest income. In this investment perspective, the Fed is basically guaranteeing a floor under short-term bond prices
Do I think such Fed intervention will be effective? Nope. I think Fed intervention exacerbates economic uncertainty. The idea that a handful of economists is a surrogate for an economy of over 320 million consumers and thousands of business is beyond hubris.
A Note About My Deceased Friend Bruce Breeding
[I accidentally lost a long edit where I discussed that widow Susan had discussed little of Bruce's medical history, e.g., if he had relevant risk factors like being overweight, having diabetes, high blood pressure or bad cholesterol readings, if long work hours stood at the expense of regular exercise, like our racquetball games at UH. Let's be clear: strokes don't come with warnings; you show symptoms after it has happened; the faster you get help after symptoms appear, you can mitigate the damage. One of the things I hoped Susan might do is to help educate readers understand the risk factors, so they don't experience similar tragedies. Note that strokes can happen despite medical tests showing no heart or carotid artery symptoms.]One item stuck out at me in one of Susan's posthumous posts: Susan mentioned that Bruce's mother spent the last 5 years or so of her life recovering .from a stroke. I just couldn't believe this was the first time in over 6 months of blogging this was mentioned. Let's be clear: risk factors are correlated, not causative. Just because his mother suffered one doesn't mean it was Bruce's destiny; his surviving siblings have not had a stroke.But in my experience, almost every doctor goes over family medical history, so I'm sure Susan has discussed this issue several times with Bruce's doctors over the past 6 months. I just don't recall reading about it from the blog before (it could be I overlooked it or missed a relevant post.
Pro Wrestling Notes
Well, for weeks WWE had been teasing a (long overdue) heel turn for Seth Rollins for a while. I thought they might do it at Survivor Series, turning rogue on his Raw teammates, allowing NXT to win. But post-PPV when he started ranting at the rest of the roster, and they walked out on him. That was definitely a sign of an imminent heel turn; it was just a question of when and how.It finally happened this week as quasi-babyface Kevin Owens became a target of the returning Authors of Pain. Now one detail I left out above is KO stayed behind while the rest of the roster walked out on Rollins to confront him on his BS. AOP's subsequent attack on KO, without a tag ream partner, was puzzling. KO spent Monday's episode trying to chase down AOP armed with Rey Mysterio's pipe and finally attacks AOP's limo. AOP assaults KO outside the limo--and who should emerge from the limo--but Seth Rollins. Presumably we should learn more about the Rollins/AOP faction and/or new recruits over the weeks ahead.
The other interesting storyline is Randy Orton feuding with AJ Styles, costing Styles' US title to Rey Mysterio (and his mandatory rematch Monday). It's not clear why Orton would go after Styles unless he thought of taking the title from a weaker champion Mysterio. I will point out Styles is allied with OC tag team. Maybe they're fusing storylines with AOP taking on the OC, Orton allying with Rollins and KO aligning with the OC? It's also unclear who's next to challenge Brock Lesnar.
