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Tag: yield curve

Szn 3, Episode 27: Forget Inflation — Deflationary Forces Are the More Vexing Issue

Content Highlights

  • The market is pricing in a series of interest rate hikes for the coming 24 months. But the Fed has backed off of a tightening schedule before (2:18);
  • Bonds have been selling off, but investors will find themselves on the wrong side of this trade when Fed backs off of tapering (4:07);
  • Inflation is a supply-side problem that the Fed doesn’t have control of. Markets are too fragile to handle rate hikes (5:06);The latest FOMC meeting where tapering was announced “was probably the most dovish taper you could come up with” (9:20);

  • Deflationary forces, starting with China, are a major issue the market is overlooking. This despite the best (non-publicized) efforts by the Chinese government (10:49);

  • It’s not just China though; demographics and debt are part of the longer-term trend toward deflation (19:19);

  • Background on the guest (22:33);

  • What about potential headwinds, from China or elsewhere? (24:58);

  • Unwinding Evergrande: Where is the exposure? (29:05);

  • How much longer can the Fed taper before their hand is forced to back off? (31:17);

  • What indicators should investors keep an eye on to monitor this situation? (34:35).

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Season 3, Episode 17: Don’t Fear Inflation, the Fed is Right, 10-Year Yields to Drop to 0.5% (Updated)

With Alfonso Peccatiello, The Macro Compass

(Adds transcript to the bottom of this page. To get the transcript sooner, and take advantage of a host of other benefits, become a premium subscriber).

Alfonso Peccatiello joins the podcast to discuss his contrarian views on inflation, bond yields, and interest rates.

The guest doesn’t buy the inflation narrative entirely, believing credit creation has peaked. We are likely to see negative economic surprises and drawdowns in risk assets starting in the fourth quarter. The yield on 10-year bonds should peak at 0.5% due to a ‘Eurofication’ of the U.S. yield curve.

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Contrarian Calls, Revisited: Barry Knapp on Yield Curve Inversion

What Was Said

In this podcast’s pilot episode last April, economist Barry Knapp of Ironsides Macroeconomics discussed the economic news of the day: the 3-month/10-year yield curve inversion.

The conventional wisdom at the time was that the yield curve inversion would lead to recession in the U.S.

But there had been numerous “false positives” from the yield-curve indicator in the past, Knapp said: 1966, 1998, and 2005. “There was no evidence that the inversion of the yield curve was really having any demand side effects on the actual availability of credit,” he said at the time. “It’s not debilitating for growth.”

The U.S. consumer remained healthy as households continued to delever from the excesses of the 2008 financial crisis. “The savings rate is high, income growth is picking up,” Knapp said. While global exports were slowing, this was “not enough of a shock to drive the U.S. into a recession.”

Additionally, there were reasons to believe the inversion wouldn’t last long. The Federal Reserve was indicating that its next Treasury-buying initiatives were more likely to lead to a steepening of the curve.

Knapp was bullish on bank stocks, having upgraded his view in 2017. He also liked U.S. small caps, expecting a rally on domestic demand.

What Happened

Ten months later, there are no signs of recession for the U.S. economy. Financial stocks have done well, judging by the SPDR S&P Bank ETF (KBE), which is up more than 14% in the intervening months:

Small caps have also done well, with the iShares Core S&P Small-Cap ETF (IJR) gaining more than 11%:

The 3 month/10 year yield curve stayed inverted for a few months before steepening. It has since inverted again, though this time few economists are calling for a recession.

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