why does the yield curve move?

[fmjvertigo123]

sorry guys maybe stupid question, but is it just the goverment deciding, how much interest to give you, simply because they need money fast. for e.g. the inverted yield curve.
is this a good sign of a bad time, maybe even a recession is among us?

 

[Martinghoul]

The yield curve moves because investors make decisions about which bonds to buy/sell and then act on them.

 

[fmjvertigo123]

lol, how wrong was i! shows you should never take anything thing for granted! and shows everything works off supply and demand. so i guess it was a stupid question, with a stupid assumption

so when you say which bonds to buy/ sell, you mean the goverment bonds mart. so obviously when theres an inverted yield, that just means investors are buying more short term bonds because they are scared the goverment will go bust?

 

[Martinghoul]

Firstly, remember that lots of buying of bonds means yields go down, not up. So, funnily enough, if you think about govt bonds perceived to be at risk of default, the yield curve will be inverted, but that's because people don't want to own short-term bonds and prefer long-term bonds instead.

 

[fmjvertigo123]

but that doesnt make sense to me though. usually they say its a predictor of recession right an inverted yield curve. however if the bonds yield goes down cause there are huge amount of buyers, thus sending 30yr treasury bonds alot lower. why would people want to own 30yr old bonds when the goverment might default the currency at bad times. wouldnt you want to buy short term instead???

 

[Martinghoul]

Well, firstly, don't listen to conventional wisdom. An inverted yield curve can occur as a result of many different things (for example, in the UK the yield curve has been inverted since 2004 or smth; that doesn't mean it indicated any sort of a recession). Secondly, you're right the shape of the curve is a complex interaction of a few volatile factors, one of which (default/inflation risk premium) you have mentioned. That's precisely the reason that one shouldn't listen to simplistic and overly general conventional wisdom. You should always try to understand the main drivers yourself and have an idea of what matters the most at any given time.

In principle, there are three things that can determine the shape of the curve: rate expectations, risk premium and convexity. If you want to understand more, read Antti Ilmanen "Understanding the Yield Curve" series of papers.

 

[fmjvertigo123]

awesome thanks for that mart! will definately pick that up soon !
by the way what sort of trading do you do ?

 

[Martinghoul]

I do rates.

 

[fmjvertigo123]

In principle, there are three things that can determine the shape of the curve: rate expectations, risk premium and convexity. If you want to understand more, read Antti Ilmanen "Understanding the Yield Curve" series of papers.

you couldnt expand on what, "rate expectations, risk premium and convexity," is could you please mart?

 

[Martinghoul]

you couldnt expand on what, "rate expectations, risk premium and convexity," is could you please mart?

Do you wanna try reading the papers by Antti Ilmanen first? You can find them on the web...

 

[fmjvertigo123]

of course, sorry bro! i thought it was a full blown, book. im already reading "reminicences of a stock operator." so i thought better do one at a time !
my father had a word with a guy about buying greece bonds, he said that they may offer 13%, but at the end they will probably only give you 2%! i thought if you buy bonds you either get the % you had or nothing at all, would you mind shining a bit of light on this for me mate?

 

[Martinghoul]

Well, bonds rarely default fully where you get back zero. In most cases, the bond undergoes what's known as a restructuring, which means you get smth back, but it's worth less. Even in a full-blown default, there's some recovery, where the lender can seize the borrower's assets and thus recoup some of their losses.

 

[fmjvertigo123]

im going through the papers now mart, theres a few things i dont understand, that i've tried searching on the web for
1. barbells
2. bullets
3. convexity
if you could tell me what they mean, that would be fantastic mate!
i feel im going learn alot from these papers

 

[fmjvertigo123]

thats the paragraph if that helps any mate

"If convexity bias were the only reason for the concave
average yield curve shape, one would expect a barbell’s convexity
advantage to exactly offset a bullet’s yield advantage, in which case
duration-matched barbells and bullets would have the same expected
returns."

 

[arabianights]

Hey fmj,

Are you the guy who complained to a certain "Jack M" (very close to ya - and we'll leave it at that) about my manners on t2w?

If so...

HAHAHAAHHAHAHAHAHAHAHAHAHAHAHAHAHAAHAHAHAHAHAHAHAHAHAHAHAHAHAHA

 

[fmjvertigo123]

haha lol, i havent complained to anyone! complain about what exactly?

 

[arabianights]

ah I'm probably mistaken then, don't worry....

 

[fmjvertigo123]

k man np!