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Economic Outlook: Difference between revisions
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# If investors see higher odds of a recession, the long-term inflation risk premium in Treasury bonds will fall. In recent recessions, the risks of unexpectedly low inflation have increased relative to the risks of unexpectedly high inflation. This is explain because in periods of low inflation, the fixed nominal cash flows from a nominal bond become more attractive, driving up the prices of these bonds and lowering their interest rate. | # If investors see higher odds of a recession, the long-term inflation risk premium in Treasury bonds will fall. In recent recessions, the risks of unexpectedly low inflation have increased relative to the risks of unexpectedly high inflation. This is explain because in periods of low inflation, the fixed nominal cash flows from a nominal bond become more attractive, driving up the prices of these bonds and lowering their interest rate. | ||
# If investors see greater risk of recession, they will attribute higher value to short-term assets that they can easily liquidate to finance spending on goods and services. Hence, they will require higher compensation to keep holding long-term securities. This means a yield curve inversion in this escenario is an expectation of lower odds of a recession. <span style="color:red">Last sentence unclear. Overall this correlation does not exist (?) esp. since there is a reverse repo facility.</span> | # If investors see greater risk of recession, they will attribute higher value to short-term assets that they can easily liquidate to finance spending on goods and services. Hence, they will require higher compensation to keep holding long-term securities. This means a yield curve inversion in this escenario is an expectation of lower odds of a recession. <span style="color:red">Last sentence unclear. Overall this correlation does not exist (?) esp. since there is a reverse repo facility.</span> | ||
#<span style="color:red">From my understanding the major factor which is influencing yield curves is interest rate expectations. Due to communication that Fed interest rates will go higher than previously expected there has been a sell-off in short term treasuries (-> higher short term interest rates + more inversion). Long term yields are reflecting the fact that interest rates are expected to go down. See inflation/dot plot. </span> --[[User:PirateCaptain|PirateCaptain]] ([[User talk:PirateCaptain|talk]]) 20:55, 28 December 2022 (UTC) | #<span style="color:red">From my understanding the major factor which is influencing yield curves is interest rate expectations. Due to communication that Fed interest rates will go higher than previously expected there has been a sell-off in short term treasuries (-> higher short term interest rates + more inversion). Long term yields are reflecting the fact that interest rates are expected to go down. See inflation/dot plot. </span> --[[User:PirateCaptain|PirateCaptain]] ([[User talk:PirateCaptain|talk]]) 20:55, 28 December 2022 (UTC). ''Yield curve will always be influenced by interest rate/policy expectations, thats pretty straigh forward, but what you need to understand is why those expectations exist, other the FED comunication, since the FED credibility is pretty bad at this moment. The inverted risk premium between maturities mean investors see greater risk for the economy in the short term, and hence requesting more return for the risks taken. Investors moving from short to long term bonds, is a sign of expected distress in the economy in the near future. This is the academic explanations, and I was just using the FED research in this matter, and is the explanation given in most articles you find. But I personally, also think of the yield curve in terms of economic activity/inflation expectations.'' | ||
Due to these contradictory reasons, not all yield curve inversion will signal a recession, thats' why is important to understand the current enviromnent we are in and the sentiment among inversions. Since several surveys has been done recently already, especially the latest Philadelphia Fed survey of professional forecasters showing the probability of a recession in the next year is the highest in the 50+ years this survey has been conducted<ref>https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q4-2022</ref>, we can conclude that this time investors are pricing in mostly higher odds of a recession in the yield curve inversion. | Due to these contradictory reasons, not all yield curve inversion will signal a recession, thats' why is important to understand the current enviromnent we are in and the sentiment among inversions. Since several surveys has been done recently already, especially the latest Philadelphia Fed survey of professional forecasters showing the probability of a recession in the next year is the highest in the 50+ years this survey has been conducted<ref>https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q4-2022</ref>, we can conclude that this time investors are pricing in mostly higher odds of a recession in the yield curve inversion. | ||
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In the residential investment data displayed in Figure 12 there is one false positive in 1951-2 and another in 1966 -67. In both cases housing was weakening substantially but there was no recession. Why is that? Those two false positives occurred coincidentally with a big ramp-up in defense spending for the Korean War and the Vietnam War. Alarms of forthcoming recessions that were met by a response that prevented the recessions from occurring. | In the residential investment data displayed in Figure 12 there is one false positive in 1951-2 and another in 1966 -67. In both cases housing was weakening substantially but there was no recession. Why is that? Those two false positives occurred coincidentally with a big ramp-up in defense spending for the Korean War and the Vietnam War. Alarms of forthcoming recessions that were met by a response that prevented the recessions from occurring. | ||
Also important to point out that is | Also important to point out that is volumes that matter for real GDP accounting, not prices. Prices can matter indirectly through a wealth effect, but be a little skeptical about this. And that the sluggishness of price adjustments is what makes the volume cycle so extreme, and what makes housing so important in recessions. | ||
What is the current data telling us? | What is the current data telling us? | ||