Re: Inverted yield curves - not a big deal?

["ÁÎ×Ó¹â HenryC.K.Liu ¹ù¤l¥ú" <hliu@xxxxxxxxxxxxxx>]

thorthor wrote:

> Goldman Sachs had more to chew on than just the inverted yield curve.
>
> The gold market went haywire on Friday, with the price of gold rising by over 8 %, and
> the share prices of gold mining companies between 15 - 25 %.  What prompted this was an
> announcement by Placer Dome -- a behemoth North American precious metals producer --
> that they would cease selling forward their gold, and not add new hedges to their
> hedgebook. Such hedging practices, while profitable for the firms, served to keep gold
> liquidity high and its price low.  This coincided with rumours that Goldman Sachs got
> into a short squeeze on Friday, on hedges tied to gold,  which forced the company to
> cover such bets, by forcing the company to buy huge amounts of gold, feeding into the
> surge in the price of the yellow metal. Its price surged to  $312, from $290.
>
> What a double whammy for GS, the inversion in the yield curve and the gold short
> squeeze. Still, there are no media reports to back up the rumours the company is in
> trouble (or Deutche Bank, the other company mentioned in the same instance).
>

I noticed that too.
I have a freind who is treasure for a major gold producer in the US, she said they would be
laughing all the way to the bank ecxept that they have hedge all the upside to hedge funds.

>
> In relation to the inversion of the yield curve, there are two reasons why this should
> NOT be a problem.
>
> 1) Derivatives players should have learned from the 1998 experience not to make
> simplistic "convergency assumptions", betting that a given differential in yields of
> different instruments remains constant.
>

"Should have learned" is never operational in the market. Those who have long memories never
make money.  The are aged brokers who explained to the young turk managers why theri
performance is below par.
Further, in the hedging game, the counterparty of conservatism is risk-taking.  The net
impact is always overshooting, either way and exacerbated by defaults that break the chain.

>
> 2) the drop in the 30 year yield had been anticipated in the debt management literature,
> associated with the US government surplus and an orderly draw down of the debt. Hence
> this  shift in the maturity structure was by and large expected to occur mostly at the
> long end (with the 10 year bond serving as the long end in most other countries), raising
> their price.
>

Don't forget that every trader thinks he can be to last to exit.

>
> It is therefore surprising, if professional derivatives players had assumptions in place
> that ignored both factors.
>

Happens every time.

Henry C.K. Liu

>
> "ÁÎ×Ó¹â HenryC.K.Liu ¹ù¤l¥ú" wrote:
>
> > It may not be a big deal to economists, but it is certainly a big deal on Wall
> > Street.
> >
> > The bond market was thrown into chaos, with rumors of LTCM scale losses to banks,
> > brokerage houses and hedge funds on the wrong side of the Treasury moves. The stress
> > to the system is extraordinary, some are using words such as "unprecedented".
> >
> > The NY Fed issued denials in early afternoon on the day the Fed and the Treasury
> > made their separte moves (Febuary 3rd), of calling a LTCM type special session to
> > assess the damage to the market.
> >
> > Wall Street firms regularly short longterm government securities to hedge their
> > large portfolios of mortgages and corporate bonds.  The current market is deadly for
> > these positions. Goldman shares dropped 6.3% on the same day.
> >
> > Historical data suggest the it usually takes 6 month to absorb structural changes of
> > the yield curves, and usually with much pain.
> > The deal can be very big by summer unless the Treasury and the Fed put their heads
> > together.
> >
> > Henry C.K. Liu
> >
> > Greg Nowell wrote:
> >
> > > Speaking of Prof. Davidson's assertions that events are not ergodic--when is an
> > > inverted curve not inverted?  When supply considerations and hoarding at one end
> > > of the curve in one asset category causes a "distortion" not generally
> > > followeld.
> > >
> > > During hte Asian crisis, foreign investors piled into US securities and the U.S.
> > > treasury went down to 4.75% and the 0 point 30 year home mortgage followed down
> > > to about 6.5-6.625%.
> > >
> > > Today, the 30 year Treasury, in a much calmer environment, is nose-diving on
> > > speculation about its scarcity.  The 30 year zero point home mortgage is at
> > > 8.25%.
> > >
> > > What this suggests is that the inverted yield curve in govt secs is not
> > > indicative of major yield curve realignments in general markets and taht it is
> > > therefore not an indicator of crisis.  This lends plausibility to the theory
> > > that there's a lot of speculative hoarding of 30 year notes so that p[rices on
> > > the margin are rising.  -gn.
> > >
> > > Clifford Poirot wrote:
> > >
> > > > The following article appeared in today's NYT.
> > > > http://www.nytimes.com/library/financial/fed/020100fed-place.html
> > > >
> > > > In the event the link does not work, the article states that the efforts by
> > > > the Treasury to buy back debt has predictably, pushed long term rates down.
> > > > At the same time, the Fed is pushing short term rates up. Predictably, the
> > > > yield curve is now inverted, and this may worsen over time. A major change
> > > > in the markets also aggravates the situation. Most loans are now created in
> > > > the capital markets by issuance of bonds, rather than through the banking
> > > > system.
> > > >
> > > > I am sure most of us are familiar with Kaldor's work "The Scourge of
> > > > Monetarism" where he pointed out that not only was Monetarism bad theory and
> > > > bad policy, but that it could not even be executed due to the inability of
> > > > central banks to meet M2 targets. It seems that the process of
> > > > disintermediation is actually weakening Central Bank control further.
> > > >
> > > > Have we now reached the point where the Fed cannot only not meet M2 targets,
> > > > but can no longer hit an interest rate target?
> > >
> > > --
> > > Gregory P. Nowell
> > > Associate Professor
> > > Department of Political Science, Milne 100
> > > State University of New York
> > > 135 Western Ave.
> > > Albany, New York 12222
> > >
> > > Fax 518-442-5298