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  • Martin Sosnoff

Let Economists Worry Over The Negative Yield Curve

For 2- year Treasuries its yield premium over 10-year counterpart still widens, unrelentlessly. I bought a basketful of 2-year notes when their yield premium was 50 basis points. Now it’s 80 basis points. So… I’ve a fat paper loss on what I believed was a lay-up, riskless play.

The Great Humbler, (the market) retains lessons for me: Do what you believe is conservative, then lose some capital. Passive investors, who abhor risk lost 16% past year in their pie chart, 60–40 investment constructs. What major banks do with client capital, year after year.

FRB policy initiatives do forge charts on interest rates. The Fed mulls inflation at 5% and wants to drive it lower. So, Fed Funds stick at 5%. When I turned to my chart on 10-year Treasuries, I was surprised by what I encountered.

Ten-year notes traced a gigantic sombrero, peaking at 15% when Paul Volcker elected to rid the country of its inflationary expectations. He single handedly destroyed Jimmy Hoffa and his press for 7% wage increases for his United Auto Workers in 1983. Volcker won, and made the country universally competitive.

I’d x-out another spike to 15% for Treasuries, bringing it down to 10% and then place the long term trendline at 5%, where we hang presently.


10-YEAR TREASURY BOND VOLATILITY



Source: Federal Reserve Board



Historically, I’ve traded against FRB intentions, that they are misplaced, foolish, and bound to change. Alan Greenspan hyped the Fed Funds rate dozen times, sometimes bi-monthly. His record of hyper activity extended for years. The International Monetary Fund and other sources of punditry are reported on religiously by our financial press, but nobody takes a stand on their efficiency or timeliness.

The IMF, after studying its baseline economic forecasts found their errors were so great as to make them practically useless for suggesting policy initiatives. Staff economists just blamed a world rich in economic and political upheaval, oil, for example. Sort of what we’ve got on our hands at present.

Consider, after Black Monday, interest rates collapsed based on the census view of impending recession. The FRB changed horses in midstream, from tightening to easing credit. Forecasting errors seem universally shared. Policy makers attend the same forums, stay at the same hotels, and share comparable data and ideas. Nobody ever gets his GDP forecast on the money more than one-third of the time. If you keep forecasting 3% GDP growth and get 2% or 4%, your error counts up to 33%, sometimes more.

I was not prepped by my trusty charts on long term interest rates, inflation and comparative yields on Treasury bills and bonds. First impression, my charts showed a restless, nervous energy that was awesome. GDP growth and actual consensus showed no rhyme or reason. The market missed its forecasts as much on the upside as downside.

The average rate for Fed Funds, I’d put at 5% past 30 years, higher at turn-of-the-century, then 6%, but trending much lower in recent years. How can you explain 2-year Treasuries with over a 4% yield to maturity? Well… Investors in 10-year paper see much higher interest rates ahead. That’s their bet that 10-year bonds head much lower, and soon yield over 4%, a positive construct.

Net, net the 10-year Treasury note currently is a bear bet on rising interest rates, but it could take years for a workout. The 2-year bond will get you to par at maturity. Soo your only cost is opportunity cost. You could have done better with your capital, but, now punished for your bad entry point.

Next time you see Treasuries yielding 15%, buy them, the longest maturity you can find. History is on your side unless the world goes up in flames. Not my call.


The negative yield curve for me is a curious twist, that investing conservatively can cost you serious money. Think of the wipe-out in American Telephone stock past years. Electric utilities once considered prime yield stocks with growing dividends yielding over 4% are no longer competitive with most fixed income investments. Duke Energy is a good example.

Conversely, nobody ever mentions that owning ragamuffins (under $10 stocks) with good entry points can go around the clock three or four times during a cycle. Check the price cycle in Haliburton, US Steel, Alcoa, and Schlumberger. Carl Icahn implemented this strategy, but stock choices and overconcentration have given him bruises.

I struck out with Lehman Brothers in 2009, but Bank of America‘s preferred stock carried me from 5 bucks to $25 during the banking debacle. In the fifties, I knew families with one dollar cost on their IBM stock. Later, searching through the IBM wreckage in 1991, I saw that their shareholder list remained largely intact.

Tom Watson had bet his company on development of the 360 computer and won. But, by 1991 IBM needed to be saved by an outsider of a different religion, namely, Lou Gerstner.

Sooner or later you discover embedded financial risk in every asset class under the sun, starting with Treasuries.



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Buddy Love
Buddy Love
05 juin 2023

The comment about policy makers group think reminds of the firehouse effect. Firemen spend a lot of time together and over time share the same opinions (sometimes way off the mark).

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