Great explanation of how an inverted curve helps create a deleveraging cycle, Alf! I really enjoy that fact that you matter-of-factly integrate the ponzi aspect of our financial system that should be obvious to all at this point: it's a grow or die world as far as the global mountain of debt goes, given the longer term disinflationary forces at work. Given that, the level that real rates can rise to gets lower and lower before rates must either turn back down again or start a deleveraging bust of one size or another.
Great piece Alf... Enjoyed the article. I knew Treasuries have credit risk, but thought it was so small market didn't price it. Didn't realize there is a credit spread... :)
CME is offering swap rates for SOFR, however they comes in different DTE, would it be the front contract that is the most suitable Choice for following the spread relationship?
Because OIS swaps capture the expected return an investor would make in parking cash at the Central Bank over time - which is the purest form of risk-free investment you can think of in today's monetary system.
May the same reading be extrapolated to the Eurozone? I see on BBG that the 5Y-30Y of the EUR OIS swap curve (number 133 if I am correct), is barely 33 bps.
Really like this info. For a guy like me that is relatively uninformed it would be helpful to label exactly what each axis of the chart is exactly to remove any ambiguity for the uninformed. Just a suggestion from the guys like me that need help.
Hey Alf. Thanks for this wonderful piece; and for all the invaluable macro insight you offer us.
One question if I may - why is it that when the yield curve is inverted, the marginal cost of refinancing and accessing new credit short-term increases? Many thanks!
Mr. Alf, what are your thoughts on using the classic definition of a yield curve inversion (as defined by Dr. Campbell Harvey) which is when the 10-year treasury yield is below that of the 3-month treasury yield? What are the pros/cons of this classic definition compared to yours? Isn't it true that the classically defined inversion correctly predicted every single recession with 100% accuracy going back to the 1970s?
Hi TD! 3m10y works too, but for 3m yields to move up such that the curve inverts you literally need the Central Banks to have hiked already. Using 2y or 5y yields gives you a more timely idea of what the market expects the Central Bank to do with short-end rates before having to wait for them to actually take action.
Just eye balling your chart the difference in the 5yr 30yr OIS looks closer to 46 than 16...?? Although I do understand why you"re using the OIS I just don't see that it's showing anything more critical than the traditional method??
Great piece. So, this is the rationale for plotting credit spreads against the yield curve (inverted and shifted forward by 24 months). It tells you about the timing - unfortunately only more or less - of the credit-spread blow-up
Thanks Alf. Learning loads. I have been following you on Twitter. Investing.com has free access to IRS swaps (USDSB3L2Y=,USDSB3L5Y=, USDSB3L10Y=, USDSB3L30Y=).
My pleasure! Can't check right now, but 99% sure those are Libor swaps.
Hence they do not reflect the term structure of Fed Funds rate, but the term structure of Libor rates (which have interbank risk associated with them).
This explanation on yield curves helps my understanding greatly. The "why" part especially. It fills in some gaps in my mind that other writers created. Much appreciated.
Great explanation of how an inverted curve helps create a deleveraging cycle, Alf! I really enjoy that fact that you matter-of-factly integrate the ponzi aspect of our financial system that should be obvious to all at this point: it's a grow or die world as far as the global mountain of debt goes, given the longer term disinflationary forces at work. Given that, the level that real rates can rise to gets lower and lower before rates must either turn back down again or start a deleveraging bust of one size or another.
Could not have explained it better myself!
Alf
Great analysis thank you. Now, can you go further- how and when do we prepare for it.
Of course, coming soon!
Great piece Alf... Enjoyed the article. I knew Treasuries have credit risk, but thought it was so small market didn't price it. Didn't realize there is a credit spread... :)
Eheh :) more to come about this topic on The Macro Compass!
Really informative, easy to read article! I will definitely recommend it for friends/fam looking to expand knowledge on the subject - Thanks Alfonso!
Thank you!
CME is offering swap rates for SOFR, however they comes in different DTE, would it be the front contract that is the most suitable Choice for following the spread relationship?
https://www.cmegroup.com/trading/interest-rates/swap-futures/5-year-eris-sofr-swap_overview.html
https://www.cmegroup.com/markets/interest-rates/swap-futures/30-year-eris-sofr-swap.html
Thank you for taking the time to help us understand these important market indicators
My pleasure, Colin!
Great Article, for an equity guy, why does taking the OIS curve removes counterparty risk?
Because OIS swaps capture the expected return an investor would make in parking cash at the Central Bank over time - which is the purest form of risk-free investment you can think of in today's monetary system.
Hi Alfonso,
Wonderful post. Thank you very much for writing it.
Best regards
Javier
Glad you liked it!
May the same reading be extrapolated to the Eurozone? I see on BBG that the 5Y-30Y of the EUR OIS swap curve (number 133 if I am correct), is barely 33 bps.
Yes, and flattening quick.
i like how you called deleveraging the devil. Its something the elites should of just got out of the way years ago
Deleveraging works against the very nature of how our economic system works.
Really like this info. For a guy like me that is relatively uninformed it would be helpful to label exactly what each axis of the chart is exactly to remove any ambiguity for the uninformed. Just a suggestion from the guys like me that need help.
Thanks for bearing with me.
I will do that, Andy.
Hey Alf. Thanks for this wonderful piece; and for all the invaluable macro insight you offer us.
One question if I may - why is it that when the yield curve is inverted, the marginal cost of refinancing and accessing new credit short-term increases? Many thanks!
Because often it means front-end yields have gone up, and that means refinancing maturing debt or accessing new credit becomes more expensive.
Thanks Alf, but what if the one decides to refinance at the longer end of the curve - on long maturities instead?
Mr. Alf, what are your thoughts on using the classic definition of a yield curve inversion (as defined by Dr. Campbell Harvey) which is when the 10-year treasury yield is below that of the 3-month treasury yield? What are the pros/cons of this classic definition compared to yours? Isn't it true that the classically defined inversion correctly predicted every single recession with 100% accuracy going back to the 1970s?
Hi TD! 3m10y works too, but for 3m yields to move up such that the curve inverts you literally need the Central Banks to have hiked already. Using 2y or 5y yields gives you a more timely idea of what the market expects the Central Bank to do with short-end rates before having to wait for them to actually take action.
Just eye balling your chart the difference in the 5yr 30yr OIS looks closer to 46 than 16...?? Although I do understand why you"re using the OIS I just don't see that it's showing anything more critical than the traditional method??
Sorry for not putting numbers on the chart, but that trades at 16 bps today.
What does the impulse mean, how do I measure it and/or find it. Sorry if this is a stupid question
The growth impulse is the pace of change of the growth rate.
Basically if the economy is growing, is it growing at an accelerating pace or not?
Now, it's not.
the growth impulse, he said it was a combination of certain economic indicators
Great piece. So, this is the rationale for plotting credit spreads against the yield curve (inverted and shifted forward by 24 months). It tells you about the timing - unfortunately only more or less - of the credit-spread blow-up
Pretty much yes, Giorgio
Thanks Alf. Learning loads. I have been following you on Twitter. Investing.com has free access to IRS swaps (USDSB3L2Y=,USDSB3L5Y=, USDSB3L10Y=, USDSB3L30Y=).
My pleasure! Can't check right now, but 99% sure those are Libor swaps.
Hence they do not reflect the term structure of Fed Funds rate, but the term structure of Libor rates (which have interbank risk associated with them).
This explanation on yield curves helps my understanding greatly. The "why" part especially. It fills in some gaps in my mind that other writers created. Much appreciated.
Glad it helped!