Against the backdrop of the latest events in the USA and Europe, many analysts began to predict a new financial crisis that will bring down stock markets in the near future.

However, until recently, these were just another loud forecasts. Now, we see that these forecasts begin to be supported by specific facts and numbers.

There is such a popular indicator that accurately predicted all recessions of the last 50 years - the inversion of the curve of the treasury bonds.

More recently, this indicator caught fire in red light. And, then we will talk about what this indicator signals, how to calculate it and what we wait in the near future.

A little about bonds

It's no longer a secret that the United States spends a lot of money. When income is not enough to cover their expenses, they sell bonds.

The government bond is an agreement between the government and the investor.

If we are talking about 10-year bonds, the contract will sound like this: to the one who buy this bond, the state will pay 5% annually for 10 years, after which the deadline will come, and the state will return your money to you.

This agreement does not change during the period. Therefore, if you invested $ 1000 in a bond, then every year you will receive $ 50, and when the bond period expires, the state will return you $ 1000.

Bonds are traded in the open market. You do not have to sell your bonds, you can keep them before the deadline and wait for the fulfillment of the obligation by the state.

At the same time, if the market offers you an attractive price for these bonds, you can sell them and make a profit before repayment.

Why does the bond course fluctuate in the open market?

You will have to wait for 10 years (if you consider the last example) to return your $ 1000. And that if the state releases 5-year bonds that can bring investors the same money.

Obviously, they will take up the buying up of these fresh bonds and will not be particularly interested in the 10-year bonds that you have.

The market price of your bonds may fall, however, it will still bring you 5% per annum for 10 years, after which you will receive your $ 1000 back.

If the price of the open market falls to $ 900, the bonds will still bring you $ 50 per year, and you will still receive your $ 1000 back after 10 years.

But, also, this will mean that if investors buy such bonds for $ 900, their profit this year will be 5.6%. And if they keep bonds before the maturity, they will also receive their $ 900 + $ 100 on top.

But the price of a bond may grow (if there are fewer interesting things on the market). However, as the market price rises, the profitability of the bond falls, because, they will give only $ 50 a year, and after 10 years you will receive less than you paid.

Revenue curve

The next thing you need to know is government bonds can have a different interest rate and repayment period. If we apply them to the schedule, then we will teach the schedule of the profitability curve.

The normal returns usually take this form:

Short -term bonds offer lower profitability than long -term bonds. Since investors expect economic growth.

Economic growth can lead to inflation, which can force the Fed to increase interest rates. Therefore, investors are looking for a higher profitability for these bonds to protect themselves from this risk.

However, recently, we are observing the leveling of the profitability curve - the profitability of long -term bonds is reduced, and in short -term - it increases.

The thing is that the left side of the profitability curve is very dependent on the solution of the Fed regard to interest rates.

If inflation at high levels, the Fed begins to increase interest rates, making loans more expensive in the hope of stopping further inflation growth.

The Fed has already planned a number of bets of bets in the following years. The profitability schedule of long -term bonds is reduced because investors see problems that come in the short term and more and more want to fix long -term income.

This causes rise in prices for long -term bonds and a decrease in their profitability. Therefore, the return curve is smoothed out.

If the future looks rainbow, the curve looks healthy, if the future looks vague, then the curve can smooth out or even roll over.

Many analysts, instead of evaluating all existing bonds with different maturity, compare only 2 bonds: with 10 years and with a 2-year period.

Half a year ago, this schedule looked quite normal, but now we have almost a flat curve before us. And more recently, inversion really happened in it.

Why should we worry this?

Of course, no one is able to predict the upcoming recession. But every time the curve on the schedule turned over, this was followed by a recession.

The schedule predicted each recession over the past 50 years - that is why investors around the world tensed out of the world who recently happened to this curve.

And here you need to give some explanations. Despite the fact that this indicator predicted the last fall, he cannot tell us when it will happen (this can take several months or several years).

It is also worth noting that so far we are not dealing with a stable period of inversion. If inversion is preserved for a longer period of time, then the probability of a recession will increase many times.

But at the moment we are probably observing one -time technical inversion. And we must remember that the stock market and the economy are not the same thing.

After the inversion of the yield curve of 2-year and 10-year bonds (in various periods of time), the profitability of the stock market was not catastrophic.

In 5 cases, S&P 500 grew with a 2-digit pace 12 months after the inversion of the return curve.

For today, thanks for your attention!

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