Greece Government Bond Yields Inverting

The inversion has begun again in Greece government bonds. Normally, higher maturity bonds have higher interest rates, because they are riskier to hold due to inflation. But sometimes the yield curve inverts (see chart below created by Correlation Economics).

As you know, 2012 was the year where Greece defaulted on debt as low maturity bonds crashed (yellow chart peaks out).

We might be seeing take two of that crash in 2015 as low maturity bonds are now re-inverting against high yield bonds. For more info, go here.

U.S. Bond Yield Curve Vs. Fed Funds Rate

There is a correlation between the yield curve and the Fed funds rate.

The yield curve plots the yield on Y-axis and maturity on X-axis. A flattening yield curve means that the yield of the different maturities are coming together and a recession starts.

On the following graph, the flattening yield curve can be witnessed by a drop to zero on the blue chart. Whenever this drop happens, a recession starts and the Federal Reserve comes to the rescue by decreasing the Fed funds rate. The problem today is that in the next recession in 2015, the Fed funds rate cannot be lowered anymore (red chart is already at 0%). The Fed is out of bullets.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Ugt

Dividend Yield Vs. Bond Yield

It pays off to compare the dividend yield and the bond yield in the U.S.

A very long time ago, before 1970, dividend yields on stocks were on average priced at 120% of the triple AAA bond yields. So if a bond gets you 10% return, the dividend yield would get you 12%. That’s because stocks can default and are riskier than bonds which are less likely to default.

But since 1970, this has changed.with the rise of mutual funds. The ratio of dividend yields versus bond yields dropped to around 20% (see chart below). Today we are at 100% so we are back in line with history (with stocks just a little bit overpriced). Just keep in mind that we have the 120% rule and try to follow this rule (to keep your sanity in these volatile markets).

U.S. bond yields can be found here:
//research.stlouisfed.org/fred2/graph/graph-landing.php?g=QA9 Dow Jones dividend yields can be found here:
http://www.investmenttools.com/equities/fundamentals/dow_jones_dividend_yield.htm

Correlation: Carry trade Vs. Stocks

A carry trade can occur when a currency A is borrowed to buy another currency B. That other currency can be used to buy assets like equities (or short gold).

There are two prerequisites to have a profitable carry trade.
One, the currency A needs to depreciate against the other currency B.
Two, the yield on the other currency B must be higher than the carry traded currency A.

A famous carry trade is the yen carry trade where yen are borrowed to buy U.S. dollars. We have seen this during the housing bubble from 2003 to 2007 where yield spreads were very high (see chart below) and we are seeing this happening again today in 2013-2015 where we have again a stock bubble.

Whenever this yield spread narrows again, the probability of a crash increases. I see this carry trade yield spread as a leading indicator for the stock market.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Q2X

Euro/USD exchange rate Vs. U.S. Bond Yield

The Euro/USD exchange rate is highly correlated to the U.S. Bond Yields.

Money flows to U.S. bonds at the same time when people flee into the U.S.dollar. So whenever U.S. bonds go up (U.S. bond yields go down), the U.S. dollar strengthens.

Let’s look at the Euro/USD exchange rate as an example. Mastering this correlation will give you an edge whenever arbitrage occurs.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Ipf

U.S. Treasury Yields

This page is created to monitor the U.S. treasury yields. Recessions can be predicted clearly as they coincide with narrowing yield spreads.

As you can see, the yield spread narrowed in 2000 and 2007, which were the omens of two recessionary events: NASDAQ bubble and 2008 crisis.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=HNV

Predicting the Recession via Narrowing Yield Spread

There is a nice metric to predict a recession of which I talked here.

Basically when the 10 year yield to 3 month T Bill yield spread narrows, you’re probably nearing a recession.

This is the status today. Nothing much happening today, but we will see below that something is starting to happen. See chart below from Nowandfutures.com.

And in more detail:

Go here to read the analysis.

Bank Deposit Vs. Interest Rate

There is a very interesting correlation between bank deposits and the deposit interest rates that I haven’t noticed yet.

Whenever yields are low, be it that the government lowers interest rates or imposes taxes on deposits. The result is that people will flee out of bank deposits and move their money either into equities or gold. Or anything else for that matter. This is because investors are searching for yield on investment. If interest rates are low, they will find a better use for their money than putting it in a bank.

Take Spain for example. Ever since the treasury yields peaked out in 2012, the same happened in the bank deposits in Spain.

Spain 10 Year Yield

As you can see here, the peak in Spain deposits (green chart) can also be found in 2012.

Eurozone deposits

QE As Far As The Eye Can See

I don’t think we will ever see a taper again and here is why. One simple chart.

As you can see the 10 year treasury yield is now at 3% and surprisingly, this is almost as high as during the 2008 financial crisis, where the yield was 3.6%.

But there is one big difference between then and now and that is that the U.S. public debt has doubled from $9 trillion to $17 trillion.

So today we are worse off as compared to 2008. To keep yields down I don’t see any other option than QE to infinity.

There is this question on how long QE can continue to raise equity prices. Do you think this can go on till infinity?

Of course not, first off, I showed with the Potemkin anti-rally that the Dow Jones hasn’t been rising along QE. But more importantly, we need to watch what the U.S. dollar is doing.

That’s why I made this chart to show the Dow Composite Index, weighed to the U.S dollar index ( blue line). You can see the blue line has been flat lately, even though the Dow Composite went up ( green line). That’s because the U.S dollar has been going down recently (TWEXMMTH). The red line shows the expanding Fed balance sheet.

We need to keep monitoring this, because once the green and blue line diverge from each other, we’re basically going into hyperinflation mode.

30 Year Fixed Mortgage Rate Vs. 30 Year U.S. Treasury Yield

This page is created to monitor the 30 year Conventional Fixed Mortgage Rate Vs. 30 year U.S. Treasury Yield.

There is an obvious historical correlation here. The thing to watch here is that the mortgage rate (blue chart) should always be higher than the treasury yield (green chart).

When this is not the case, U.S. treasury yields should decline / mortgage yields should increase.