Traders Prepare for Fed Rate Rise as Global Government Bonds Drop

Government debt markets have been under pressure as central banks begin to cut back on pandemic-era policies. In order to encourage the flow of money, the governments had put stimulus policies in place to support the economy.

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Labor productivity hasn’t increased, but there is more money because of stimulus checks hence the resulting inflation. The dollar index, which measures the US currency against six others, traded at 103.5 points, close to a two-decade high.

In modern world investment, US government bonds are the most reliable instrument for investment. It has become a reference point in the coordinate system of investment risks.

It is a statement of fact, no matter how you feel about it, and no matter how much you listen to it on TV, that the American national debt will soon end.

The Goldmans, Morgans, and other manipulators (puppeteers) don’t have nationwide television channels tuned in, so they continue to wildly buy up the American national debt. Why are there manipulators — even Russia’s notorious frozen gold reserve due to the situation around Ukraine (more precisely, its dollar part) lies mainly in American government bonds.

The yield of these government bonds can serve as an indicator of the mood of the world’s largest investors. How it works: I explain on the fingers.

The further a bond’s maturity date, the more yield it gives. Everything is clear here on an intuitive level: if you lend money for a more extended period (for example, for 10 years), then you take on more risk than if you lend money for a short period (for example, for 2 years). This means that you count on a more significant return when you give your money for a long time. So it is almost always. But not always…

Source: Y-Charts

The colors in the figure indicate:

  • Green — periods when long (10-year) government bonds yield higher than short (2-year).
  • Red — periods when short (2-year) government bonds yield higher than long (10-year).

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Red periods don’t last long — a few months, and sometimes just a few weeks. At these moments, manipulators get rid of their short government bonds (their price falls -> their yield grows) and buy long government bonds (their price rises -> their yield falls). And that’s just the “red zone” is called the inversion of the yield curve, which you can hear that it is a 100% indicator of a future crisis!

Why is it considered an indicator of a crisis? Because such inversions almost always happened a few months before the crisis!

Source: TradingView

Recessions (crises) are marked in gray in the figure. Recessions have always been some time after the inversion. The US Federal Reserve has been tracking this metric for 45 years. Some sources report that it was the same (starting from the 50s) earlier. And this happened again last week! On Friday, April 1, 2022, the yield on 2-year US government bonds was 0.06% higher than the yield on 10-year ones, which, under normal expectations from the economy, should not be.

This is the second time the yield curve has been inverted. What is fantastic, but the previous inversion “predicted” the coronavirus pandemic!

In this article, I’ll not discuss whether a recession will occur when it happens and for what reasons. It’s better to look at the statistics around previous inversions and subsequent recessions over the past 45 years.

1980 Inflation

The 1980 recession was caused by high inflation and the Fed’s actions to bring it down. Very similar to today’s situation. Short bonds outperformed long bonds in August 1978. The recession began in February 1980.

Before the crisis, the market grew by another 10% (excluding dividends paid out over 1.5 years). It fell slightly below the values ​​it was at when this terrible indicator “predicted” the future crisis. The market fell slightly (2–3 months) and slightly (-17% from the peak). It was a pretty mild recession for the stock market, and it looks like you shouldn’t have exited the market, waited 1.5 years, and then tried to hit the perfect entry point. After all, you and I know that usually, during such periods, it seems to us that stocks are about to fall even more.

1981 Iranian revolution, the oil crisis

In 1981 there was a revolution in Iran. The country at that time was one of the largest exporters of oil, and after the revolution, production fell catastrophically. This caused a recession in the US. And this recession was also predicted by our indicator.

The market hung around for about 10 more months after that (+4%), after which it began to fall. The stock market’s fall was long (more than a year fell). Recovery was speedy. Once we know the future, getting out of stocks was the smart decision. True, we were not there, and we don’t know what it’s like to wait 10 months for a fall, but nothing happens.

1990 War in Iraq, the oil crisis

In 1990, one of the biggest brawls in the Middle East was followed by a particular operation (non-war) codenamed “Desert Storm.”

Short debts became more profitable than long ones in January 1989. Only after 1.5 years does it all slide into a recession. During this time, the market grew by 28%, excluding dividends. The stock market during the recession never fell to the level it was during the inversion. The indicator accurately predicted the crisis, but it was useless: exiting the stock would be a terrible decision.

2000–2002. Dot-com bubble

One of the biggest and longest crises for the stock market is the dot-com bubble. The “new economy” companies grew like mushrooms, inflating a vast bubble after the rain. The fall was deep and protracted. For the economy, this wasn’t such a massive problem as for the stock market, so the recession didn’t last long, and the economy’s recovery began against the backdrop of the continued decline in the stock market — this also happens.

The indicator worked perfectly: the inversion happened in February 2000, and from that moment, the stock market didn’t grow for long. By the beginning of the recession, the stock market had already fallen by 18%. The drop in the NASDAQ technology index was enormous; in the more sectorally diversified S&P500 index (pictured), the market fell by 50%.

2008 Real estate bubble, global financial crisis

A mortgage boom in the US a few years before the crisis. Mortgage derivatives were very popular and promised high returns to buyers. Few thought about the risks. Expensive oil caused a slowdown in the economy, which caused an increase in unemployment. People were unable to pay their mortgages, and the house of cards collapsed. At the height of the crisis, Lehman Brothers went bankrupt, after which the financial system went to hell.

And again, the yield curve inversion occurred 1.5 years before the recession began! It looks like you really should have jumped out of stock. True, another 1.5 years later, the market grew by another 18%. All these 1.5 years, a person guided by this recession indicator would look at growth stocks and reflect on the correctness of the choice made.

2020 Pandemic

The yield curve inversion occurred in August 2019. This happened literally for a week, and then the main version of where the recession would come from was the version of a trade war between China and the United States.

The market then continued to grow; the United States and China agreed on everything at the end of 2019. Then something happened that doesn’t require a description since we continue to live under pandemic restrictions, and the WHO hasn’t yet announced the end of the pandemic. Nevertheless, the recession in the American economy (just like in the world) was a record short one, the economy quickly recovered, and the stock market rose strongly. Of course, the indicator worked, but it was tough to catch the moment when the game on exiting the stock market and entering back would be profitable. We all know examples when people failed and bit their elbows. It all happened way too fast.

2022–2023?

The inversion has happened again. How long this will last is unknown. There were also “false” short-term inversions, after which the recession didn’t occur. This was the case, for example, in the summer of 1998, when manipulators believed that the Asian financial crisis (and the Russian default that followed) would trigger a recession. But that didn’t happen. The inversion then was short and insignificant.

Here are some conclusions you can come to:

  • Yield curve inversion is a truly significant event. Indeed, it always points to problems in the global economy. Only once did it happen that there were problems, but the crisis didn’t occur. In other cases, she “predicted” a crisis.
  • If your investment strategy is medium-term and involves significant shifts in the portfolio every year or every 2-to 3 years, you should thoroughly study this topic; it is of decisive importance.
  • As a rule, the stock market after the inversion continues to rise for several more months. So if you are going to play timing — pay attention to it. In all analyzed cases, the sale of shares 6 months after the start of the inversion (and not immediately) gave the same or better result.
  • Recessions happen often. If your investment strategy has a long horizon, you should not be afraid of them. You have to get used to this fact. Selling shares and waiting for a couple of years without a trading position wasn’t always the best decision for a long-term investor.
  • “I saw the inversion — I sold, the end of the recession — I bought” is a terrible strategy. It worked fine only in the 2008 crisis. It would take three years. The recession ended when stocks had already risen significantly. Also, remember that we’ll learn about the recession’s end in about 5–8 months after (all macroeconomic reports signaling the end of the crisis should come out). More often than not, the stock market was already significantly higher by this point.
  • Inversions say nothing about the exact time the recession began. Absolute random took from 7 to 19 months from inversion to crisis.

Inversions say nothing about the depth of the recession, much less about the depth and duration of the decline in stocks. No patterns were found.

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Disclaimer: All investment strategies and investments involve the risk of loss. Nothing contained in this article should be construed as investment advice.

Abiodun Ajayi has more than 6 years of experience in Security and IT architecture. He consults and helps form strategies, perform project feasibility studies.

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Abiodun Ajayi

Abiodun Ajayi

Abiodun Ajayi has more than 6 years of experience in Security and IT architecture. He consults and helps form strategies, perform project feasibility studies.

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