An inversion of the rates curve doesn’t necessarily mean a recession. Does it?
While an inverted yield curve is usually an indication of a recession, the current flattening can also be explained by supply and demand distortion on a massive scale due to three main factors:
- The Fed’s QE programme, coupled with Operation Twist in 2012, were designed to lower long term bond yields and force the flattening of the yield curve in order to force investment in the real economy. The aim was to increase the velocity of money by increasing risk taking.
- Subdued inflation driven by the disruptive effects of technology replacing the labour force and the globalisation of the labour market, has lowered long term inflation expectations.
- US corporates are making investments in their underfunded pension plans before September 15th 2018, taking advantage of a 14% tax benefit by making a deduction at the old prevailing tax rate of 35% instead of 21%. These contributions end up being invested in long dated treasuries causing further yield curve flattening.
Investors have therefore been reserved in backing a steepening of the rates curve. Unlike previous tightening cycles, this one in particular will see a very large runoff of duration as the Fed unwinds its balance sheet.
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Kokou joined SG CIB in 2014 and was most recently Head of Equity & Derivative Strategy Europe at BNPP in London for 4 years, where he was responsible for European fundamental equity strategy, derivatives parameters, global cross-asset themes and convertible bonds strategy. He was team leader of five senior strategists ranked #1 for idea generation by Greenwich survey & Derivatives Intelligence. Prior to this, he started his career on the trading side: Executive Director at JP Morgan from 2009-2010 and from 2000 to 2008 he was a portfolio manager at Goldman Sachs Principal Strategies (GSPS). He managed directional long/short, convertible bonds and volatility portfolios across asset classes.
Born in Togo and educated in China, where he spent 12 years of his life, Kokou Agbo-Bloua graduated with an MSc in Management from HEC School of Management in Paris in 2002, and completed his post-graduate studies in Finance at the Anderson School of Management at UCLA. He is frequently quoted in the financial press and is a regular guest speaker on the BBC, Bloomberg and CNBC.
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