Yield Curve Inversion Part Two

After raising rates till May 2000, the Fed then does NOTHING for 7 months....From January 2001 till June 2004 the Fed lowers rates 550 basis points from 6.5 to 1%, and here we are today.

This is what happens when the yield curve inverts. The carry trade gets destroyed, positions unwind and market equilibrium is dislocated.

A combination of things caused this disaster. One, the rise in low end rates by the FED which initiated this sequence from November 1998 until May 2000. Too much, too fast. Two, the bond markets reluctance and latency to react and price the high end accordingly, causing the initial inversion. Three, the exodus of cash from the Nasdaq in part, held the bond market down at the high end. Thus causing the severe and total inversion. Four, once it became apparent an inversion was going to occur, the FED waited around for over 7 months while the curve inverted and markets imploded, they did not act quickly enough in reducing the short term rates to restore the curve.

The dollar fell 40% during the rate lowering period, MZM money supply was increased by 50%. Oil went from $12 to $55 a barrel, and real estate "values" doubled and tripled in some areas.

These are reasons why interest rates are going up again, the dollar needs to strengthen to keep commodities prices down, bonds need to be sold to foreign banks to finance our debts, stagflation and inflation must be kept tame. Will he raise them too high, too fast?? His track record speaks for itself.

This time the bond market better react accordingly, if high end rates do not keep going up in step with low end rates, we will see another inversion. You better start praying that the economic indicators are not bullshit. There better be a recovery coming, and corporate America better do its part in creating jobs and raising wages, no more jobless recovery. If this doesn't happen, that will be the curtain going up for Act 2 in a play we have already seen before, and it ends in tragedy in Act 3.


See : Yield Curve Inversion Part One - February 20, 2005

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