The yield curve went from steeply inverted to nearly flat and is now becoming more steeply inverted. 
Chart Synopsis
- In May we had one of the most steeply inverted curves in history.
- In a devastating selloff in treasuries between May and October, the yield curve steepened to a much flatter state.
- The 5-year and 7-year treasury notes were most impacted, rising 1.46 percentage points and 1,48 percentage points respectively, in about 5 months.
- The inversion increased through November and on December 1, the curve is about half-way between the May state in early May and early October.
Notice point two, with apologies to Game of Trades on Twitter. He commented the yield curve was steepening and I said it was flattening. The curve did steepen, but the result was a much flatter state.
The Shape of the Curve
Inverted Double Humped
I created that chart a few weeks ago, adding the last two shapes, steep (positively sloped) and inverted humped. The first four shapes are from Financial Edge.
I created the inverted humped shape (more accurately double humped) by turning the humped state upside down, then applying a perspective warp change in Photoshop. Turning the chart upside down alone will put the hump in the wrong place.
Financial Edge describes the humped shape: “A humped yield curve, also known as a bell-shaped yield curve, is a rare type of yield curve that occurs when interest rates on medium-term fixed income securities are higher than the rates of both long and short-term instruments.”
Investopedia says “Although a humped yield curve is often an indicator of slowing economic growth, it should not be confused with an inverted yield curve. An inverted yield curve occurs when short-term rates are higher than long-term rates or, to put it another way, when long-term rates fall below short-term rates. An inverted yield curve indicates that investors expect the economy to slow or decline in the future, and this slower growth may lead to lower inflation and lower interest rates for all maturities.”
There is no discussion of the inverted humped shape anywhere that I can find, but that is the current state.
Weird or Something Else?
That looks weird because it is not the yield curve.
An accurate curve it needs to be to scale. On my chart, every vertical line is 3 months apart, with the Fed Funds Rate at point 0.
Even if we mentally smooth out the second hump (light blue dashed line), an inverted hump shape remains.
Smoothed Chart Removing Second Hump
The darker dashed blue line shows we are not dealing with a normal inversion. Starting at 5 years the curve steepens.
I suspect illiquidity of the 20-year bond explains the nature of the curve between 10 years and 30 years. So, mentally smooth it out with that as I did above.
What about the rest of the curve?
Three Possible Explanations
- Regarding the huge inversion between 1 month and five years, then strongly steepening: Could it be the bond market smells a short quick recession followed by a big inflation problem coming down the pike?
- Risk aversion: Risk aversion is another possibility. Investors are happy with shorter term bonds and demand increasing more out of justifiable fear of what might happen.
- What about the fed? Does the market finally understand the Fed is no longer in control?
The Decline in Inflation is Transitory
The short explanation is the bond market believes the current year-over-year decline in inflation is temporary or at least has a fear that it might be.
Also, the Fed never was in control, but tail winds of global wage arbitrage, just-in-time manufacturing, and outsourcing made it appear the Fed was in control. Long-term doubts may be surfacing.
No One Will Fix This
On September 7 I offered this view: Debt to GDP Alarm Bells Ring, Neither Party Will Solve This
“Neither party will fix the deficits. Neither party will do anything about mounting debt. No one will do anything about anything because the political system is totally broken.” Mish
But when do the deficits and debts matter?
That was the focus of a follow-up post on December 3,
When Does US Federal Debt Reach an Unsustainable Level?
Please consider When Does US Federal Debt Reach an Unsustainable Level?
A possible message of the Treasury market and gold is that neither believes the Fed is in control or won’t be starting five years from now.
Bitcoin advocates would say Bitcoin is sending the same message.
Please see the above links for discussion. Then if you have any other explanations for the double humped inverted curve, please comment.
The Fed knew what would happen. 2009 we never had inflation, 2020 was deliberate
The real yield curve is slightly positive from 1 year out which I think is about 1.85%.
https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_real_yield_curve&field_tdr_date_value_month=202312
This is more normal curve and it’s certainly not indicating a tight monetary stance. Is the Fed happy with this? I doubt it given they want to be sure they’ve conquered inflation.
In the next year and a half $3T of corp debts, mostly junk and $7T gov debt will
mature. The $10T will choke the market and drain liquidity from the private sector.
Did you possibly get one too many negatives in the statement: “The short explanation is the bond market believes the current year-over-year decline in inflation is temporary or at least has a fear that it might not be.”
Yes Thanks!
Mish, we often hear of a FED put in regards to the stock market, but rarely in terms of treasuries. Could there be an implicit FED put given the vast amount of treasuries held to maturity at banks? Could we also be seeing market manipulation through quantitative tightening?
Good Question
The Fed PUT is on the banks, not the interest rates per se, but they are related.
The Fed will do anything, not to rescue the stock market, but to stave off any collapse of the banks or the economy.
In turn that rescues the stock market as a side effect.
I assume it is demand driven. With the most recent inflation read, the bond and stock markets seem to believe inflation is coming down sooner than previously expected. The long-term part of the curve reflects higher demand for long-term bonds due to lower inflation expectations.
The short-term part of the curve is dominated by FED policy. I do not believe the yield curve would be inverted if the FED cut the policy rate to 2.00%. The 3mo-5yr would follow suit. I assume the bond market does not believe the FED will cut rates soon, so the rates are higher there.
Like Mish said, the 20-year is a liquidity/demand issue. It only recently started getting used again. Money managers aren’t sure where it fits. The 10-year and 30-year are more comfortable.
“Risk aversion: Risk aversion is another possibility. Investors are happy with shorter term bonds and demand increasing more out of justifiable fear of what might happen.”
That’s me. Also, I’m retired. Thirty year bonds are of no interest to me at all. Even twenties are only of slight interest. Demographics is a thing.
Well well, the fed is “not in control”?
This comment made by Mish can be interpreted in two ways.
1. Mish is incorrect. Why? How so?
Simple, the illusion the Fed is nothing control is a perfect storm to raise rates, again. When the blame is on the Fed for rate increases…. The rate to which rate s”need” to be reached are hindered or delayed. War. For example redirects the blame of rising rates to the war effort . This happened in both the first and second wars, Korean and Vietnam wars…. Soon to be the escalating third world war.
2. Mish is correct, the Fed is not in control. And the revelation by the public will be realized, soon. When some adverse anomaly affects the interest rates. Moving them higher, suddenly. “Not in control” is not synonymous to “knowing” or anticipating rates going higher. The Fed may not have control, though what is a well ekpt secret from the public eye? That all central banks are completely aware of the possibility of higher rates and why.
My two cents this morning
Disaster incoming! Time to panic!
Not my expertise either; but I would use TIPS to break out the real yield curve and the break even inflation curve. Last time I looked at this breakdown at the 10-year horizon, both the real yield and the break-even inflation rate were declining together in November. So, stories about investors expecting a huge burst inflation beyond the short term don’t look very convincing.
On the subject of the political system is broke I agree but if you list what voters
consider important it does not make the list . Any candidate running on sound
responsible government fiscal restraint and the government having to make
responsible decisions will not be electable . In fact any attempt to control
spending by a candidate or party is demonized as they are coming after your
benefits ect. So does the political parties not represent the majority of the
people because the people do not want address the unsustainable trajectory
even though the math says it has to be. The government has lived of of deficits for
so long running to a budget is just not and option considered by the voters or
the politicians .
if the treasury were
printing the money it would not matter but since the Fed is charging us interest on every dollar we were doomed from the start of this counterfeit machine
The front-end is where the FED plays. And I expected more U.S. debt downgrades. It is surprising that with the draining of the O/N RRP and the transfer of funds from bank accounts to MMMFs, that rates haven’t fallen further.
More debt down grades. Good point. This article and few others Mish has spoken of. 20 years, assuming everything stays the same…… As simple as down grading the US t bills? What inevitably happens? Interest rates go up! And we should discuss here, why rates go up….. And in my mind it’s simple…. Productivity of the economy or the people or the working money falls. Hence why the need for higher rates. In the past higher rates will create incentive to increase productivity…… Unfortunately. The productivity curves in the western world has fallen quite rapidly inbthevlast decade and a half. And clearly the most rapid during or since COVID.
20 year projection made by Mish, has not discussed the microeconomics such as down grading bonds. The 5% vs 6% suggesting moving the impact date from 2050 to 2045 has become that much more real. Great point.
Downgrading bonds is irrelevant and I have said so before.
The US is not going to default so is logically AAA.
The US will have to either default, or pay creditors in Zimbabwe dollars. Cost-free, tabletop cold fusion possibly excepted; There are no other outcomes possible anymore.
More fundamentally, and per any standard less arbitrarily malleable than the current “nominal” one; the US defaulted when FDR debased. It has since been serially defaulting, on last minute’s promises every year since.
America is so far into the hole now, that even the most throuroughly indoctrinated and economically illiterate population in history; simply will not accept the strictures required to actually pay off the debt in anything resembling today’s dollars. They’ll either vote for someone who promises to simply default (the intelligent choice); or they’ll keep up folloing Argentina even further than they already have: Paying off bond holders with fresh print at an ever accelerating rate, until the debt is nominably “manageable.”
correct
NOT going to default? are you joking?????the us already defaulted twice in just the past century. 1932 and 1971. go back to civil war and post revolution if you really want to clutch your pearls.
Zimbabwe dollars. That is the future. Government will just keep printing and devaluing. We are in a plane that has passed the point of no-return. But don’t worry we have enough fuel to get to the crash site.
The only way out of this situation is austerity. Politician can’t tolerate austerity. Neither can the public. It is a painful and very long route to stability.
My reply was to Stuki Moi
not my primary area of expertise. But I have heard that Janet Yellen is trying to finance most of the deficit these days with very short term debt …..that would help to explain why rates are inverted, there’s a huge demand for short term money. I suppo9se she’s trying to make the credit rating of the USA still look good, but it plays hell with the banks balance sheets……..
Good point
Short term loans can only last so long. Or support what is inevitable.
These short term loans are likely a delay tactic for the short term curves. I suspect. All right war could spin this trend of buying? Two things are accomplished by war.
1. Rates go up to where they need to be
2. The Fed is not to blame for higher rates.
Rates need to go higher. Why? Because the demand destruction policies we have witnessed so easily in the last three or so years are not working to achieve the same demise , fast enough. War will get us there quicker.
The interest rate inversion, double hump. Is a clear signal that rates should have been raised higher sooner. The public wasn’t ready for them. The pause or the trough in interest rate hikes. Was a great moment for certain people to get positioned for the next phase.
When will the next phase begin? Likely before thev2024 election?
We shall see
In my experience, the FED errs in both directions raising too much and for too long and lowering too far to too long
It has already reached an unsatinable level that is with we are having stability problems …. Its just going to get worse . . . Great Work Mish . . .
The “Eurodollar University” man, Jeff Snider has done a couple of recent podcasts that are WORTH YOUR and YOUR READER’s TIME to listen to them:
There are two I just heard: 28 and 29 Nov:
“Global Bank Liquidity is Drying up Fast.”
“Banks around the World are Preparing for Something Big.”
Mish, Jeff talks about the Curves, steepeners, etc. and it is quite compelling information to listen to and he “CUTS to the CHASE” well and his podcasts are quite often less than 20 mins – – which is not a lot of time commitment for this juicy information.
I also Listen to Brent Johnson, and I have reached out to him personally and will be meeting with him some day soon. I would like him to help me manage my Money.
Brent IS one of the most balanced Minds out there in the world of Macro/USA Economics and he explains his Dollar Milkshake theory well. I listen to every one of his podcasts.
He will say things like, “I could be wrong on Gold, and if I am, then I am fine with it because I am a closet Gold Bug.” GOOD STUFF.
He always says that: I could be wrong, and if I am (on the markets) I am PREPARED for that outcome, too. GREAT stuff.
All prudential reserve banking systems have heretofore “come a cropper”.
Snider acts as if the E-$ system is a cause, rather than an effect – of U.S. Fed policy. The E-$ was a superfluous and harmful addition to the world’s domestic money stocks. Its contraction is the only thing holding up the $’s exchange rate.
I will take a look at Jeff Snider.
My comment on the liquidity crises…. Yes. It seems as though the pause of better liquidity in the markets is slowly eroding . The next event, is very likely around the corner .
Mish is talking about the double hump in the rates curve. Inversion again? This likely means we can expect rates to go up. Short recession, and high inflation…. Soon after? Very likely. Especially with world war around the corner? War can do two things. 1. Cause inflation 2. Cast the blame for higher rates upon the enemy (not the Fed, not upon the govt)
Perfect storm
Again thanks. Will check out the podcasts you suggested.
I do not buy his Eurodollar thesis at least as he presents it some of the time.
Snider’s is sometimes a good read but lacks an adequate knowledge of money and central banking.
Bernanke caused Eurodollar #1. Sheila Bair caused Eurodollar #2. Bernanke caused Eurodollar #3, etc.
Listened to Jeff Snider with George Gammon. In short. Jeff appears to be an optimist. Rates are meant to be always low? I would love to ask him, why he thinks fed rate below 5% is natural? Yet Jeff’s theory is that rates want to trend lower…. I find this extremely difficult to agree with….I would disagree and say the opposite. That banks will tend to want 10% not below 5%. Why? Considering the bleak out look for the next 20 years as Musk points out. How or why would the banks want 5% or lower?
I follow Snider on Twitter and see most of what he writes. He follows me. I mostly but not always agree with what he says.