Why Is the Yield Curve Inverted? (Jan 25, ‘08)

 

The Fed lost much of its influence over long term bond prices once sovereign wealth funds (e.g., China) became majority shareholders of these instruments. Rational actors price risk according to, as people have pointed out previously, recessionary trends and other factors that affect opportunity cost. [Esp. foreign and lesser developed countries'] governments, however, act like institutional investors with a time horizon and risk assessment much different from that of Wall Street or Main Street.

There is an inversion in the yield curve from 6mos through two or three years because of the level ownership of these instruments in foreign countries. Sovereign wealth funds’ time horizons begin at one year and end at thirty, whereas [Wall Street and Main Street] begin their calculations, of course, at 30 days. So, for foreign governments, the yield curve is not necessarily inverted. Rather, the shape of the curve reflects the aforementioned demand assessments manifest in the levels of ownership of these instruments.

Even if the whole yield curve is inverted, however, that just means foreigners heavily value [the] stability [of US securities] over actual returns (even if ROI is negative after inflation). These cats will pay the cost of inflation for the effects of sterilization (to boost international trade) and of stimulus to their respective economies due to the phenomenon of coupling with America.