WSJ "Yield Sign" on Impact of Curve Inversion
As today’s Ahead of the Tape article in The Wall Street Journal entitled Yield Sign indicates, the United States Treasury yield curve inverted earlier this week with the two-year Treasury note now yielding more than the Treasury ten-year note. As a result, the popular carry-trades used by many on Wall Street (where longer duration securities are financed using normally lower short-term financing rates) is now close to zero if not a money losing proposition. As Jim Bianco, president of Bianco Research, notes “When the spread between long- and short-term term rates narrows, financial-company profits as a share of total U.S. domestic profits falls.” The article continues “Financial firms account for a fifth of the Standard & Poor's 500-stock index's market capitalization, and a quarter of its total earnings. And many nonfinancial firms have substantial financial divisions. The real trouble, Mr. Bianco says, could come if the yield curve stays inverted and the economy keeps soldiering on -- giving the Fed no reason to cut rates and turn the curve right-side-up again. ‘If this inversion lasts, it's going to be very painful on Wall Street,’ he says.”
Toomre Capital Markets LLC wholeheartedly agrees with the last quote and notes that transaction volumes in longer-duration securities also tend to drop during periods of inversion since liquidity providers are less willing to commit capital to positioning such securities. The negative carry and lower transaction volumes suggest that the pressure to perform will grow even more acute as the yield curve inversion remains in place. It also should be noted that some people respond to relentless pressure by conducting themselves in a less positive manner that they would not do otherwise. As a result, TCM would suggest that this yield curve inversion period is especially important for all enterprise risk and market risk professionals. There is a heighten need to be on the guard for those small problems that potentially could fester into larger issues. This is true not only at the well-established broker/dealers and banks, but also the recently established entities like many of the 8,000 hedge funds that have never experienced a yield curve inversion period. TCM welcomes inquiries from interested parties.