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The Inverted Yield Curve as an Accurate Predictor of Recession

Video Transcript: Yield Curve Inversion and The Flattened Yield Curve Explained

00:00 what’s going on investors? I came here
00:02 and today we’re gonna talk about the
00:03 yield curve; recently the financial media
00:05 has been raving about the yield curve
00:07 getting close to inverting and how it’s
00:09 a signal of a coming recession; so in
00:11 this video, we’re gonna go over what the
00:12 yield curve is, how to use it, and what
00:15 it’s actually signaling for the markets.

00:16 now the yield curve is basically just a
00:19 line that plots the yield of US Treasury
00:21 bonds with different maturity dates. The
00:23 curve lets you easily compare rates on
00:25 short term bonds versus long term bonds.

00:27 In this chart, you can see the long term
00:28 bonds are yielding more than the short term
00:30 bonds. The line rises from left to right
00:32 and when this is the case, it’s called a
00:34 normal yield curve. We will discuss flat and
00:36 inverted yield curve soon, but what you…

00:38 need to understand about a normal yield
00:39 curve is that it signals that the
00:41 economy is expanding; now if you remember
00:43 from our previous videos on the Fed and
00:45 debt cycles which if you haven’t seen
00:46 I’ll link to them above; the Fed has the
00:48 biggest influence on short-term rates
00:50 when they want the economy to expand.

00:52 They keep them low and when they want to
00:54 put the brakes on an overheating economy,
00:55 they raise the rates; now on the other
00:57 end of the curve, long-term rates are
00:59 primarily influenced by investors
01:01 expectations; if they think the economy
01:02 is in good shape, then instead of bonds,

01:04 they will invest in more risky assets
01:06 like stocks. Bonds will therefore stay
01:08 lower which means long-term yields will
01:10 stay higher; remember the price of a bond
01:12 and its yield are inversely related, bond
01:14 prices up, yields down, bond prices down,
01:17 yields up. Now when investors see danger
01:19 ahead, they pile into those same long
01:21 term bonds for safety.

01:22 This in turn raises their prices and
01:24 lowers their yield; so, all in all, when
01:26 things are looking good, the Fed will
01:28 keep short-term rates low and investors
01:30 expectations will keep long-term rates
01:31 high, and that’s why you’ll see the
01:33 normal yield curve as a result. Now let’s
01:35 talk about what happens when the same
01:36 yield curve starts to flatten or even…

01:38 invert, but before we do, remember that
01:40 analyzing the yield curve should just be
01:42 one tool in your arsenal of tools to
01:44 evaluate the market; don’t depend solely
01:46 on yield curve analysis to make your
01:48 decisions; it’s just a single input that…

01:50 will give you context to form a big
01:52 picture view of the market. We will be going
01:54 over a number of other tools you can use
01:55 to analyze the market in the future; so,
01:57 make sure you subscribe to this channel
01:59 and hit that Bell from notifications for
02:00 one of those new videos when released.

02:02 Okay! Now on to flat and inverted yield
02:04 curves. So, when you start to see the
02:05 yield curve flatten or even invert which
02:08 is when short term rates become equal
02:10 – or even higher than long-term rates
02:11 and the line either becomes flat or
02:13 slope lower from left to right, then that
02:15 usually signals trouble ahead, in terms
02:17 of a recession and lower market prices.

02:19 Things happen for the yield curve to
02:21 become like this. First, the Fed starts
02:23 raising short-term rates based on their
02:25 mandates; they see the economy
02:26 overheating, and they decide to raise
02:28 rates to slow it down; higher rates tend
02:30 to hurt economic expansions. Second,
02:32 investors expectations for the future
02:34 become negative and because of that, they
02:35 buy up long-term bonds, lowering their
02:38 yield; those two together give you a flat…

02:40 or inverted yield curve where short-term
02:42 bonds yield the same or even more than
02:44 long-term bonds; and like I said, this
02:46 signals trouble ahead; you can see how
02:47 this works in this chart comparing the
02:49 yield curve to the S&P; in 2000 before
02:51 the y2k bubble popped. The yield curve
02:54 was inverted in the following recovery.

02:56 The yield curve went back to normal
02:57 until the housing bubble, where the curve
02:59 flattened again; then once again in the
03:01 recovery, we went back to a standard
03:03 yield curve, and now today we’re seeing
03:05 the yield curve flatten once more, which
03:07 is why we’re seeing headlines that the
03:08 recession is around the corner.

03:09 Based on our team’s analysis, if you look
03:11 at the 5-year versus the 2-year bond
03:13 spread, the yield curve looks like it’s in
03:15 neutral territory; it’s on its way to
03:17 inverting, but that’s still a while off.

03:18 The last time the 5:2 spread was at
03:20 these levels, the market didn’t peak for
03:22 another two years or so. So, like we’ve
03:24 discussed in previous market views, the
03:25 bull is still alive. There’s still time
03:27 before things turn. Now, these last few
03:29 videos I made including this one have
03:31 been based off you guys’s questions in
03:33 the comments section below this video; so,
03:35 if you have any questions or want me to
03:36 go over anything in the future, make sure
03:38 you let me know in those comments, and…

03:39 also please share this video with your
03:41 friends; they need a refresher on the
03:42 yield curve. I was looking online and the
03:44 explanations about this topic are trash.

03:46 So, I hope this video helps with that and
03:49 if you haven’t already, make sure you
03:50 subscribe to this channel and hit that
03:51 bell so you’ll know when the new videos
03:53 come out. I’ll talk to you soon.

Source:
Fallible
Published on Apr 22, 2018, Youtube.

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