Media and everyone loves talking about yield curve inversion, but every time I try to read about why that happens, I never get a satisfactory answer.
One of the common answers is that 10-year treasury bonds are some of the most common, trustworthy and bonds that have a solid return. Ok sure, but that return is only worth it as long as it yields above the shorter term bonds. Once the situation inverts, we’re getting a “free lunch” type situation where investors taking on less risk (buying shorter term bonds) yield higher returns. So the explanation of their popularity during an upcoming recession doesn’t make sense specifically because the inversion itself renders the explanation moot I.e. why take on more risk and lower yield if I can take on less risk and higher yield, especially if I expect times to be tough?
Another common explanation I’ve heard is that investors want to be in longer duration bonds to “ride out” the storm. That also doesn’t make sense to me, recessions don’t last that long, there are bonds with maturities of 1 and 2 years most, why go for 10 year bond? Also, why would you wanna ride it out with long duration bonds anyway, finding yourself with more cash (using short duration) at the height of a recession is literally one of the best situations one can find themselves in, that’s been shown historically and most of investors are sophisticated enough to know that you should buy low.
Lastly, doesn’t this also present a nearly guaranteed bond arbitrage play? Short longer duration long shorter duration bonds, since eventually the yield has to revert. You won’t exactly be rich from it, but if you’re pricing in a recession, any profitable trade is already a huge advantage
So what am I missing? What is the market pricing that I’m overlooking?
Submitted September 20, 2022 at 03:59AM by ses92 https://ift.tt/GgdzlDh
