The Inverse Yield Curve and the Biden Lie - Live Trading News (2024)

The US economy is a dynamic entity, subject to fluctuations and uncertainties that can often seem unpredictable in the short term. While Wall Street’s major indexes have historically shown long-term growth, the picture can change dramatically when examined over shorter periods. This volatility underscores the importance of understanding the economic indicators that can provide insight into future trends.

One such indicator that has garnered attention from investors and economists alike is the yield curve, specifically the relationship between the 10-year Treasury bond and the three-month Treasury bill yields. The inversion of this yield curve, where short-term yields exceed long-term yields, has historically preceded economic downturns in the US.

Aninverted yield curveoccurs when short-term debt instruments (typically bonds) havehigher yieldsthan longer-term bonds of the same credit risk profile. Let’s delve into the details:

1. Definition:
   • An inverted yield curve shows thatlong-term interest rates are less than short-term interest rates.
   • With an inverted yield curve, the yielddecreasesthe farther away the maturity date is.
   • Sometimes referred to as anegative yield curve, the inverted curve has proven in the past to be areliable indicator of a recession.
2. Why It Matters:
   • The yield curve graphically represents yields on similar bonds across a variety of maturities.
   • An inverted yield curve isunusual; it reflects bond investors’ expectations for a decline in longer-term interest rates, typically associated with recessions.
3. Significance:
   • When the yield curve inverts, it suggests that investors aremoving money away from short-term bonds and into long-term ones.
   • This indicates that the market as a whole is becoming morepessimistic about the economic prospects for the near future.
   • An inverted yield curve has served as arelatively reliable recession indicatorin the modern era.
4. Spread Considerations:
   • Academic studies often focus on thespread between the yields on the 10-year U.S. Treasury bond and the three-month Treasury bill.
   • Market participants, however, may look at theyield spread between the 10-year and two-year bonds.
   • Federal Reserve Chair Jerome Powell prefers to gauge recession risk using thedifference between the current three-month Treasury bill rate and the market pricing of derivatives predicting the same rate 18 months later¹.

Despite the current appearance of a healthy economy, with growing gross domestic product and low unemployment rates, the Federal Reserve Bank of New York’s recession probability tool suggests caution may be warranted. This tool, which has accurately predicted previous downturns, indicates a notable probability of recession by 2025, based on the steep yield curve inversion observed in recent years.

The Federal Reserve Bank of New York‘s recession probability tool is a significant economic indicator used by investors, policymakers, and economists to assess the likelihood of an economic recession in the United States over the next 12 months. Developed by economists at the New York Fed, this tool relies on the yield curve to generate recession probabilities.

The yield curve is a graphical representation of the relationship between the yields (interest rates) of bonds with different maturities. Normally, the yield curve slopes upward, indicating that longer-term bonds have higher yields than shorter-term bonds. This reflects the expectation that investors demand higher returns for tying up their money for longer periods.

However, when investors become pessimistic about the future economic outlook, they may demand higher yields for short-term bonds relative to long-term bonds. This leads to an inversion of the yield curve, where short-term interest rates exceed long-term rates. Historically, yield curve inversions have often preceded economic recessions.

The Federal Reserve Bank of New York’s recession probability tool specifically focuses on the difference between the yields of the 10-year Treasury bond and the three-month Treasury bill. This spread, known as the yield spread, is a key indicator of economic sentiment. When the yield spread narrows or becomes negative (i.e., when short-term rates exceed long-term rates), it signals heightened concerns about economic growth and increases the probability of a recession occurring in the near future.

To calculate recession probabilities, the New York Fed’s model uses historical data on the yield spread and its relationship to past recessions. By analyzing patterns and correlations over time, the model assigns probabilities to the likelihood of a recession occurring within the next 12 months.

The New York Fed updates its recession probability estimates on a monthly basis, incorporating the latest data on bond yields and economic indicators. These estimates are closely monitored by investors, policymakers, and financial institutions as they provide valuable insights into the health and direction of the US economy.

It’s important to note that while the recession probability tool has a strong track record of predicting downturns, it is not infallible. Economic forecasting is inherently uncertain, and other factors beyond the yield curve can influence the trajectory of the economy. As such, the recession probability tool should be used as one of many indicators in assessing economic conditions and making informed investment decisions.

The Biden Economy: A Closer Look Reveals Troubling Realities

As the Biden administration continues to tout its economic policies as the solution to America’s woes, a closer examination reveals a starkly different reality. Despite promises of prosperity and recovery, the Biden economy is marred by numerous challenges that paint a troubling picture of the nation’s economic future.

1. Inflation Surges to Record Highs: One of the most alarming aspects of the Biden economy is the surge in inflation to levels not seen in decades. Consumer prices have skyrocketed, eroding the purchasing power of American households and putting a strain on their budgets. From groceries to gasoline, everyday essentials have become increasingly unaffordable, exacerbating financial hardships for millions of families.
2. Labor Shortages and Supply Chain Disruptions: Another glaring issue plaguing the Biden economy is the persistent labor shortages and supply chain disruptions. Despite promises of job creation and economic revitalization, businesses across various industries are struggling to find workers to fill open positions. This has led to production delays, rising costs, and diminished productivity, hindering the nation’s economic recovery efforts.
3. Misguided Policy Priorities: Critics argue that the Biden administration’s policy priorities have exacerbated rather than alleviated economic challenges. Massive government spending initiatives and proposed tax hikes threaten to further burden businesses and taxpayers, stifling economic growth and investment. Moreover, regulatory burdens and proposed mandates only serve to hinder innovation and entrepreneurship, stifling the engine of economic progress.
4. Energy Crisis and Dependence on Foreign Oil: The Biden administration’s energy policies have also come under scrutiny for their adverse effects on the economy. By prioritizing environmental initiatives over domestic energy production, the administration has contributed to soaring energy costs and increased reliance on foreign oil. This not only undermines America’s energy independence but also poses significant economic risks and vulnerabilities.
5. Diminished Confidence and Uncertainty: Perhaps most concerning is the erosion of confidence and growing uncertainty surrounding the Biden economy. Investors, businesses, and consumers alike are apprehensive about the direction of the economy under the current administration. With mounting debt, inflationary pressures, and policy volatility, the economic outlook appears increasingly bleak, fueling concerns about long-term prosperity and stability.

While the Biden administration may boast of economic progress and recovery, the harsh realities on the ground paint a vastly different picture. From soaring inflation to labor shortages and misguided policies, the Biden economy is mired in challenges that threaten to derail America’s economic future. As policymakers grapple with these pressing issues, it’s imperative to acknowledge the severity of the situation and pursue solutions that prioritize the well-being and prosperity of all Americans.

Understanding the Disconnection Between the US Economy and Stock Markets

In recent years, a growing disparity has emerged between the performance of the US economy and that of the stock markets, leading many to question the relationship between the two. While the US economy serves as the foundation for domestic prosperity, the stock markets, particularly multinational corporations, often reflect broader global dynamics rather than solely domestic conditions. This disconnect highlights the complexities of modern financial markets and underscores the need for a nuanced understanding of their interplay with the broader economy.

Globalization and Multinational Corporations: One of the key factors contributing to the disconnection between the US economy and stock markets is the increasing globalization of business operations. Multinational corporations, which dominate the stock markets, derive a significant portion of their revenue and profits from international markets. As such, their stock prices are influenced not only by domestic economic conditions but also by global factors such as geopolitical tensions, currency fluctuations, and international trade dynamics.

Tech Dominance and Digital Economy: The rise of technology companies and the digital economy has further blurred the line between the US economy and stock markets. Tech giants like Apple, Amazon, Google, and Microsoft, which command significant market capitalization, have a global footprint and derive a substantial portion of their revenue from international markets. Their stock prices often reflect investor sentiment and growth expectations on a global scale, rather than being tethered solely to US economic indicators.

Financialization and Speculative Activity: Another factor contributing to the disconnect is the increasing financialization of the economy and speculative activity in the stock markets. With the rise of algorithmic trading, high-frequency trading, and complex financial instruments, stock prices can be driven by short-term speculation and market sentiment rather than underlying economic fundamentals. This can lead to disconnects between stock market valuations and the real economy, creating volatility and uncertainty for investors.

Central Bank Policies and Liquidity: Central bank policies, particularly monetary stimulus measures, also play a significant role in influencing stock market dynamics. In response to economic challenges, central banks often implement accommodative monetary policies, such as low interest rates and quantitative easing, to stimulate lending and investment. While these measures can boost stock market performance in the short term, they may not necessarily reflect underlying economic health or fundamentals.

Implications and Considerations: The disconnection between the US economy and stock markets has important implications for investors, policymakers, and businesses alike. Investors need to adopt a global perspective and consider a diverse range of factors when making investment decisions. Policymakers must recognize the limitations of using stock market performance as a barometer of economic health and implement policies that address structural challenges and promote sustainable growth. Businesses, especially multinational corporations, must navigate a complex global landscape and adapt to evolving market dynamics to remain competitive.

In conclusion, the disconnect between the US economy and stock markets underscores the evolving nature of modern financial markets and the challenges of interpreting market signals in a globalized world. While the stock markets play a vital role in allocating capital and driving economic growth, they are not always indicative of underlying economic conditions. By understanding the factors driving this disconnection, stakeholders can make more informed decisions and navigate the complexities of today’s interconnected financial system.

S. Jack Heffernan Ph.D

S. Jack Heffernan Ph.D. Economist at Knightsbridge holds a Ph.D. in Economics and brings with him over 40 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b. He has managed and overseen start ups in Crypto, Mining, Shipping, Technology and Financial Services.