I read a research note a few months ago that the shape of the U.S. yield curve often moves into backwardation right before a recession.
Do you think it will stop steepening soon?
The ACD Method
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I read a research note a few months ago that the shape of the U.S. yield curve often moves into backwardation right before a recession.
Do you think it will stop steepening soon?
Good question Samuel. I'll respond with both theory and data. In general, the yield curve is a "leading" indicator. It tends to be one of the best predictors of market cycles which is why no one on ET watches it (sarcasm off). A steepening yield curve is very bullish in general. It usually means there is plenty of credit available for both the private and public sector and also usually indicates there is ample liquidity. Banks have greater incentives to lend because their economic incentive to do so is increasing. The steepening yield curve also is the market's way of pricing in future growth. Growth and inflation are synonymous here. So with plenty of liquidity, higher growth priced in going forward and ample credit, that is a recipe for increasing GDP and overall economic growth.
The flattening curve says the opposite of the above. That liquidity is tightening, forward growth is being removed from the market and the incentive to lend is not there.
Now, we are in kind of a unique situation here in that we have had an unusually long period of low short term rates. The previous recession ended some time ago but that was not reflected in the yield curve completely. Having said that, there is no way the yield curve should be steepening if the market truly believes this current credit expansion is going to end soon.
Now, let me provide the data. Here is a great link that allows you to look at the shape of the yield curve along with the S&P 500. Just click on either one and the opposite chart will adjust. You can clearly see how the yield curve flattened going into 2007 and how it steepened in 2009.
http://stockcharts.com/freecharts/yieldcurve.php
Now if you are asking do I think the curve will flatten anytime soon predicting a credit contraction and possible recession, I don't see any evidence to support that. I do see potential shocks along the way (both Europe and China) so we are seriously overdue for a market correction (mild one), but I don't see any data that would support a recessionary thesis. And with Yellen clearly stating that Fed rate hikes will be incremental and slow, the back of the curve will likely respond hard and fast. This will lead one to believe that the curve has a lot more steepening to go.
Agree with you on everything.
Not sure if it is off-topic, but in index vols land, I’ve seen and heard more and more “people" buying the front and selling the back. Not VIX instruments, but index.
It may be interesting to see what happens tomorrow based on Greece and China.
Edit: thanks for the link. Clearly shows that there has not been any flattening of the YC in the current bull market compared to the previous 2.
Not sure if it is off-topic, but in index vols land, I’ve seen and heard more and more “people" buying the front and selling the back. Not VIX instruments, but index.
It may be interesting to see what happens tomorrow based on Greece and China.
Edit: thanks for the link. Clearly shows that there has not been any flattening of the YC in the current bull market compared to the previous 2.
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I think what will be interesting going forward is if the market makes up for so called "lost time" during this last expansion. In other words, will the yield curve steepen at a very rapid rate to get to where it really should be had it been gradually steepening all along. That could make the yield curve trade very interesting. Considering the margin on the trade is close to nil it could offer a huge exponential payoff.
ZC, ZS and ZW had some nice moves the last few days. I saw something about rain in the growing areas, not sure if that means the move will have legs.
Interesting observation to share, discuss. WTI made a quarterly A up for me beginning of May but I had my yearly A level above it. Since then, I have been mostly long (products) on every failed A down in the lower timeframes that I could get in (anticipating we confirm a yearly a up ) but ever since making the qtr a up, crude remained sandwiched between my yearly and quarterly A up levels. I havent researched how well the dollar index correlates to this but from what I can see, it was the opposite - qtr a down confirmed but no yearly a down. In fact, S&Ps show the same behavior. I couldn't figure out this behavior.
Now that the quarterly and yearly reset in a few days, I think we will get out of this range we have been for almost 2 months now with a bang and it might be a decent enough move but with nothing to lean on, I feel I got to sit on the sidelines until the ranges are set mid next month.
Products had some movement during this time but was mainly driven due to cracks. The gas/heat spread had quite a run all the way from exactly 0 to a whopping 26 cents - thats huge! I cant help but feel I could have done much better had I focused on cracks and the rb/ho spread and if I had my number lines done.
Now that the quarterly and yearly reset in a few days, I think we will get out of this range we have been for almost 2 months now with a bang and it might be a decent enough move but with nothing to lean on, I feel I got to sit on the sidelines until the ranges are set mid next month.
Products had some movement during this time but was mainly driven due to cracks. The gas/heat spread had quite a run all the way from exactly 0 to a whopping 26 cents - thats huge! I cant help but feel I could have done much better had I focused on cracks and the rb/ho spread and if I had my number lines done.
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There is the gap. Will be interesting to see how that trade plays out.
VIX futures curve is flattening right now.
Buying the "puke" worked again. 