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How Central Bank Bond Purchases Can Weaken Yield Curve Recession Signals

Article Quant Q&A · Author: curious
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Summary

The document considers whether central bank intervention makes an inverted yield curve a weaker or stronger recession signal. The questioner reasons that keeping short-term rates low should make inversion harder to achieve, so an inversion might be more informative. The response clarifies that the relevant intervention can instead affect longer maturities: purchases of long-dated government bonds can push their yields down and flatten the curve.

This means an inversion may partly reflect central bank demand for long-term securities, rather than market expectations of a coming recession alone. The explanation is qualitative and offers no data, forecasting test, or estimate of how much intervention changes the signal. It also does not establish that every inversion under central bank buying is misleading; the key point is that interpreting the curve requires considering which maturities policy has influenced.

Key ideas

  • Central bank purchases of long-dated bonds can lower longer-term yields and flatten the yield curve.
  • Intervention in long maturities can affect the curve differently from keeping short-term rates low.
  • An inverted curve may partly reflect official bond buying rather than recession expectations alone.
  • The response gives a possible interpretation, not empirical evidence that the signal has weakened.

Tags

Fixed incomeUS marketsStatistics
Full text
# Why should central bank intervention cause inverted yield curve to be less effective as a recession signal?


# Why should central bank intervention cause inverted yield curve to be less effective as a recession signal?












Pimco's new CIO Dan Ivascyn believes that the inverted yield curve has become less effective as a signal of impending recession.

https://www.bloomberg.com/news/articles/2017-06-22/pimco-s-ivascyn-says-next-inverted-yield-curve-may-be-different

> Some see it as an almost surefire economic law: an inverted yield curve, when long-term bonds yield less than short-term debt, signals a coming recession. That may not hold true in today’s world of unprecedented central-bank economic intervention, according to Dan Ivascyn, Pacific Investment Management Co.’s group chief investment officer.

Mr Ivascyn, being CIO of the world's largest bond fund manager, should know his stuff. However, I don't understand why. In fact, I thought the opposite should be true. The inverted yield curve should be more, not less, effective as a recession indicator thanks to central bank intervention. Here is my reasoning. Short-term interest is artificially low today thanks to central bank intervention. Therefore, it is harder for long-term interest rates to go lower than short-term interest rates because short-term rates are already artificially low. So, if an inverted yield curve still happens despite artificially low short-term rates, wouldn't it be a stronger signal of recession? What did I miss out? Please correct me.

## Answer by dm63 (score 3, accepted)

https://quant.stackexchange.com/a/34895

He's talking about central bank intervention in the longer maturities, not the short end. The Fed bought a lot of long dated Treasuries, which helped flatten the curve. Hence an inverted curve may reflect all the securities bought by the Fed.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.