A World of (mostly) Flattening Yield Curves

Lately,  we’ve been discussing the Yield Curve, its flattening and inversion and how its different this time (not). This has been termed a "conundrum" by outgoing Fed Chair Alan Greespan.

Many commentators have cited foreign buying of longer-term treasuries as the reason for this "conundrum."
While the U.S. yield curve has flattened considerably since its August
2003 peak,that period hardly marks the beginning of foreign purchases
of US Treasuries.

Further, if we take a fresh look at curves elsewhere, we see this issue is not limited to the U.S. As the chart below reveals, Yield curves around the globe are flattening.

While numerous rationales try to explain away the US inversion as an anomaly, the excuse making ignores the small fact that the US is not the only country with a flattening Yield Curve: So too are Japan, UK, Germany, Switzerland, Canada and Australia. 

The yield curve inversion naysayers have yet to explain how foreign purchases of U.S. Treasuries are flattening curves elsewhere also.

click for larger graph


Source: Mike Panzner, Rabo Securities


Funny, those who try to convince you the Yield Curve doesn’t mean anything aren’t mentioning this inconvenient factoid of Global Curve Flattening.


To paraphrase Panzner:  "Given that spreads between long and short-term rates in many major bond markets (including Japan) have also fallen recently, perhaps "this time" is not so different after all? Could it be that global bond markets are anticipating an impending slowdown?"

Here’s a typical set of explanations:

1) stock-market investors fled the crash of 2001, and their alternative-investment strategies have soaked up the supply of bonds and other fixed-income securities.

2) China and other Asian countries are parking their dollars to drive up the value of the U.S. currency and keep their export-driven growth booming.

3) U.S., European and Japanese populations are aging, and with age comes an investment preference for security and income.

4) prices for everything except fossil fuels are being held down by productivity increases, international competition and excess manufacturing capacity.

-Peter Morici, international economist at the University of Maryland’s business school

At first blush, these all appear reasonable. However, a closer look reveal the flaws in each of these explanations:

1) This is belied by the enormous amount of cash and cash equivalents — trillions of dollars in money market accounts — hardly equates to "soaking up bond supply;" And, the crash began in 2000;

2) Foreign buying of US bonds cannot explain flattening yield curves elsewhere (See  chart above);

3) True dat; Now what about the very young populations in the rest of Asia and the Middle East? Or do we just pretend they are not market participants, and ignore the fact their equity markets have all soared in 2005?

4) Astonishingly misleading statement: Nothing is going up except oil? How about food, building materials, education costs, industrial metals, healthcare, raw goods, insurance, housing, precious metals — they all have risen dramatically.

While most goods have gone up in price, while a handful of items have come dwn. When we talk about electronics, note that the mechanism that brings their proces down is an economy of scale. The first few units are prohibitively expensive, essentially paying for the factories. The next wave are some what cheaper, and by the thrid iteration, they become mass produced and much less expensive. Think Plasma screens:  They have all plummeted in price — excepting, of course, for the one screen that I want.


For the numbers geeks, here are the actual changes in the 10-year vs. 2-year government bond yield spreads for selected countries since August, 2003 (which was the most recent major peak, based on weekly data, in the U.S. spread):

Country 8/29/03
Spread %
Spread %
(Positive Value
= Flattening)
US +2.496 -0.009 +2.505
Germany +1.604 +0.447 +1.157
Japan +1.264  +1.188 +0.076
Switzerland +2.186 +0.506 +1.680
UK +0.438 -0.091 +0.529
Canada +1.773 +0.118 +1.655
Australia +0.557 -0.020 +0.577


UPDATE 1 JANUARY 6, 2005, 1:31pm

Check out this Sunday’s NYT for more on this phenomena . . .

UPDATE 2 JANUARY 8, 2005, 8:31am

This is in today’s Sunday NYT

The World Isn’t Flat, but Its Yield Curve May Be
Economic View
NYT, January 8, 2006


Michael Panzner, Rabo Securities

Scatter Shots
THOMAS G. DONLAN (Editorial Commentary)
Barron’s, MONDAY, JANUARY 2, 2006

citing Peter Morici, international economist at the University of Maryland’s business school

Category: Economy, Federal Reserve, Fixed Income/Interest Rates, Inflation

Wal-Mart’s Worst Xmas in Five Years

Category: Retail

P/E Expansion and Contraction

Category: Investing, Markets, Psychology

How Bullish is the Investing Public?

Category: Psychology

The Tax-Cut Danger of “borrowing growth” (or, Laughing at Laffer)

Category: Economy, Politics, Taxes and Policy

Gold & The Wizard of Oz

Category: Commodities, Federal Reserve, Inflation

Death of Volatility

Category: Markets, Psychology, Technical Analysis, Trading

For 2006: Feedback, Please!

Category: Weblogs

Window Dressing

Category: Investing, Trading

P/E vs S&P 500 (50 Years)

As promised, today brings us to the 4th in our series of charts: P/E vs S&P500 click for larger chart courtesy of Mike Panzner, Rabo Securities > I’ll get into the significance of what this means to the markets later, but for now, note where the P/E is over the median, and its impact on…Read More

Category: Earnings, Markets, Psychology, Technical Analysis