The 10 year minus the 3 month has inverted. This sent the market into a nose dive. First a little history.
The shaded area indicates a recession. As can be seen above, the yield curve has a PHD in economics. I consider the yield curve is a reliable indicator of a recession. See my post here, here and here. Fifteen years ago, it was me and about 12 other people in the world that understand the power of the yield curve and its ability to predict recessions. Now everyone is talking about it. Just look at the “popular series” at the FRED.
Every website and news program, including the mainstream sites, is talking about the yield curve. When my little sister calls me to ask me about it, the circle will be complete.
Banks borrow short and lend long. When the yield curve inverts, this tends to put stress on the banks and crashes the money supply. I am of the view that this inversion will not last. There is no doubt in my mind, that all this talk about the yield curve has bubbled up to the FOMC members. The Fed doesn’t currently own any Treasury’s with maturities of one year or less, which represent 15% of outstanding Treasury securities. Interestingly enough, over the past few months some FOMC members (like Esther George) have been talking about moving some of the long dated bonds into shorter term treasuries. This will reflect the traditional balance sheet of the Fed prior to 2008.
The only reason the Fed has their balance sheet structured the way it does is from the mad monetary scientist Ben Bernanke. The famous “Operation Twist”, sold all the short dated Treasury securities and bought all long dated ones.
To this day, I am not sure what the point of doing this was. There was never any clear indication from the Fed that it was meant to accomplish anything.
So if the FOMC is going to move into the shorter term maturities, this will make the yield curve become very steep since they will be selling the longer dated ones and buying the shorter dated ones.
All of this is speculation at this point. No one knows what the Fed is going to do. I have serious doubt they know what they are going to do. If the yield curve keeps inverting it will begin to put stress on the banks and the data will reflect this. I want to emphasize there is a serious delay in all of this. From the time the yield curve inverts, to the time the data will show stress building, to the time the economy sinks. Remember, the yield curve inverted back in 2006 and it was not until almost 2 years later the stock market broke. The next few months will be very interesting.