Category Archives: economics

Better Ways to Sort Out What the U.S. Treasury Yield Curve Is Saying

Part of the U.S. Treasury yield curve inverted and all we got was lousy analysis!

Examples of U.S. Treasury Yield Curve, Inverted and Normal

That's actually something of an understatement. There has been an explosion of reporting about the inversion of the U.S. treasury yield curve in recent weeks. If you read any of it, you likely found it leaves a lot to be desired. Here's a random selection of recent headlines:

It's not any better if you read what academic economists have been writing either, much of which has the intellectual consistency of muddled hash. In fact, if all that analysis were laid out end to end, the last thing you'd ever reach from reviewing it all is a conclusion. You'd think achieving some sort of clarity would be both desirable and a priority because the inversion of the Treasury yield curve is believed to portend recession in the future for the economy.

Part of the problem is because the U.S. Treasury yield curve has more than one part to it than can become inverted. A lot of people will focus on some select parts of it, without taking what's going on in the rest of it into account.

That realization lies behind some more interesting analysis by MetricT at r/dataisbeautiful that offers a path to reach the kind of conclusions you'd want to reach whenever the treasury yield curve becomes inverted. Here's that original analysis from 28 March 2022, which has been updated with charts showing yield curve data through 15 April 2022 (in addition to some other minor tweaks):

Mean Yield Spread across all US Treasury Maturities as a (slightly) better recession gauge than the 10y/2y and 10y/3m yield curve spreads

The US Treasury yield curve spread (most commonly the 10 yr/2 yr and 10 yr/3mo spreads) are popular gauges of incoming recession. But those measures aren't perfect. In particular:

  • There is a noticable false positive from Sep 1966 - Feb 1967 where the 10 yr/3 mo yield curve inverted but no recession followed.
  • A "is it or isn't it?" event in 1998 where the yield curve almost inverted before returning to normal. This caused a lot of consternation at the time until it was subsequently shown to be another false positive.
  • Another "is it or isn't it?" event in 2019 where the yield curve inverted, but pundits wondered if it "inverted enough" to trigger a recession. Narrator: It did...

I've been looking at ways to improve the traditional yield curve measures. A few months ago I posted R code to graph the percent of all yield curve spreads that are inverted, which made it much more obvious that a recession was the likely outcome in 2019.

So the idea occured to me: There are (at present) 55 different yield curve combinations. What would the average of all yield curve combinations look like? That should give us a better measure of how distorted the yield curve is than looking at a single pair of spreads.

As it turns out, the average does perform a bit more accurately than the 10y/2y and 10y/3m yield curves. In particular, it fails to invert in 1998, meaning our "is it or isn't it?" has a much clearer "no" answer. And it did invert during the similar "is it or isn't it?" event in 2019 and correctly predict a recession. So it sends a clearer signal than the better known 10y/2y and 10y/3m curves.

Graph 1:

Graph 1

Top: The US Treasury yield curve as of April 15 2022. A healthy yield curve should be upward sloping. Notice the obvious bear flattening between 3 yr <-> 10 yr Treasuries. There are already inversions between several longer-duration Treasuries (inverted points highlighted in red). There is currently a technical inversion in the 30yr/20yr curve due to a preference for 30 year Treasuries due to the relative newness of 20 yr Treasuries.

Middle: The usual 10y/2y and 10y/3m spread alongside the average yield spread for all maturity combinations. Notice that while the 10y/2y is rapidly nosediving (and getting a lot of press in doing so), the average is still relatively stable, though that may or may not last much longer. So keep an eye on things, but don't overreact just because the 10y/2y curve inverts.

Bottom: Shows the percent of all Treasury combinations that are inverted. It's graphed as a percent because the total number of maturities has changed over time (for instance, the Fed introduced 7 yr Treasuries in 2009), so graphing the percent allows you to do an apples-to-apples comparison. The color scheme is simply "blue if the average yield curve spread is < 0, red if it's > 0".

Graph 2:

Graph 2

Graphs the Federal Funds Rate since 1985 and highlights times when the average yield curve is inverted. As you can see, Fed tightening has come to a screeching halt almost immediately once the average YC is inverted, and quickly starts heading downward. It suggests the Fed is going to have great difficulty raising the Fed rate, as they probably only have a few months before the average inverts.

I'll clean the code up and eventually post it on my Github repo, though it will probably take a few days.

There are two bits of good news. First, MetricT's code is available! Second, through 15 April 2022, the average of all yield curve combinations hasn't changed the low probability of recession signal of MetricT's original analysis from 28 March 2022.

We're not the only ones who recognize there's a lot lacking in current day analysis of the treasury yield curve. For additional discussion, we'll recommend adding Scott Grannis' exploration of better measures of the yield curve to your reading list as well.

Previously on Political Calculations

Signs of Stalling Growth for Earth’s Economy

The pace at which carbon dioxide is increasing in the Earth's atmosphere slowed significantly according to data recorded at the remote Mauna Loa observatory for March 2022. The following chart shows the latest development for the trailing twelve month average of year-over-year change in the atmospheric concentration of carbon dioxide:

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 2000 - March 2022

That change interrupts what had been a robust upturn in CO₂ emissions, driven primarily by China's record coal spree in recent months. The new change however coincides with indications that China's economic growth has sharply slowed in 2022, as indicated by its negative year-over-year growth rate for imports from the United States for December 2021 and January 2022.

Year Over Year Growth Rate of Exchange Rate Adjusted U.S.-China Trade in Goods and Services, January 1986 - January 2022

That reduction is attributable to China's ongoing struggle with COVID-19, which disrupted economic activity in the Earth's biggest emitter of carbon dioxide in both December 2021 and January 2021. Allowing for the lag in China's carbon dioxide emissions to diffuse into the Earth's air, we think that economic slowdown is now showing up in March 2022's atmospheric CO₂ measurements. With China's government still committed to its COVID-zero policies and still locking down millions of China's productive population for weeks at a time as coronavirus infections continue to spread in the country despite its measures, we anticipate reduced carbon dioxide emissions will show up in the Earth's air from the world's biggest carbon emitter over the next several months.

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. [Text File]. Updated 7 March 2022. Accessed 9 March 2022.

China’s "Record Coal Spree" Spurs Faster Pace of CO2 Buildup in Earth’s Air

China's fossil fuel shortage has fully reversed. Thanks largely to what is now being described in the media as a "record coal spree", the country is described as now having adequate supplies to get through the winter.

The Chinese government's "coal spree" has produced some stunning numbers for coal imports and domestic production. China's imports of coal sharply increased in 2021, as its imports dipped in December 2021 after peaking in November 2021 as China's domestic coal production soared.

China's fossil fuel shortage prompted officials to crank up domestic coal mining, resulting in record output from coal mines in both December 2021 and for the entire calendar year.

China’s coal output hit record highs in December and in the full year of 2021, as the government continued to encourage miners to ramp up production to ensure sufficient energy supplies in the winter heating season.

China, the world’s biggest coal miner and consumer, produced 384.67 million tonnes of the fossil fuel last month, up 7.2% year-on-year, data from the National Bureau of Statistics showed on Monday. This compared with a previous record of 370.84 million tonnes set in November.

For the full year of 2021, output touched a record 4.07 billion tonnes, up 4.7% on the previous year.

Since October, authorities have ordered coal miners to run at maximum capacity to tame red-hot coal prices and prevent a recurrence of September’s nationwide power crunch that disrupted industrial operations and added to factory gate inflation.

China hasn't let the additional coal it has bought and mined in panic sit around. Chinese power plants have been burning it in great quantities, which has resulted in a very noticable increase in the rate at which carbon dioxide is accumulating in the Earth's atmosphere.

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 2000 - January 2022

Given its coincidental timing with the waning of the global coronavirus pandemic, the environmental impact of China burning the coal it acquired through it's coal spree may also finally mark the bottom of the coronavirus pandemic itself.

Since we happen to be at an anniversary date for the data, we'll close by presented an updated version of this chart, which spans back to January 1960 to provide additional historic context.

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 1960 - January 2022

References

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. [Text File]. Updated 8 February 2022. Accessed 8 February 2022.

Atmospheric CO2 Trend Reverses on China’s Coal Panic

The first signs that China's efforts to address its dire fossil fuel shortage were gaining traction showed up in the Earth's atmosphere in December 2021.

Beginning in October 2021, China's government ordered Chinese coal miners to crank up their coal production. At the same time, the Chinese government ordered the country's coal traders to buy up as much of the world's available coal supply as they could from wherever they could buy it as China headed into winter.

That increase in coal mined and imported started in October 2021 was directed to China's coal-starved power generation plants and burned to produce electricity. The carbon dioxide emissions resulting from the Chinese government's emergency program to keep the country's lights on by burning more coal have diffused into the Earth's atmosphere in the months since. That additional CO₂ has started to become visible by interrupting and potentially reversing what had been a downward trend in the pace at which carbon dioxide is accumulating in the world's air. That change can be seen in the latest update to our chart tracking these monthly changes since 1960.

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 2000 - December 2021

Overall, roughly 60% of China's economy is powered by electricity produced in the country's growing number of coal-fired power plants. Looking ahead, China is not quite yet out of the woods because Indonesia, the source of over 60% of the country's imported coal, announced it would ban exports of coal to address its own potential fossil fuel shortage, caused in part by the Chinese government's response to its energy crunch. In China, the negative impact from Indonesia's export ban is being offset by Chinese miners producing record quantities of coal from their mines.

In any case, these developments mean that China will be paying more for coal, which in turn means that the world will be paying more for things produced in China using the energy produced in China's coal-fired power generation facilities.

References

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. [Text File]. Updated 6 January 2022. Accessed 6 January 2022.

Previously on Political Calculations

Here is our series quantifying the negative impact of the coronavirus pandemic on the Earth's economy, presented in reverse chronological order.

Earth’s Economy Continued Cooling in November 2021

Going by the reduction in the rate at which carbon dioxide is accumulating in the Earth's atmosphere, November 2021 saw a net reduction in economic activity on the planet.

Since July 2021, much of that decline is associated with COVID-related disruptions of manufacturing production in southeast Asia, and also a shortage of fossil fuels that developed in China, which forced the Chinese government to shutter energy-intensive manufacturing. While both situations have somewhat abated, their disruptions still negatively affect the world's economy given the region's relatively "early" position in global supply chains.

A good example of that impact can be seen in the global market for new steel and aluminum production, where Chinese foundries provide the materials used within the country and elsewhere in the world for higher value production. China's production of steel and aluminum has fallen significantly in the last several months. That reduction has created shortages of materials for other countries like Germany, whose economic output has been greatly reduced as a result.

Here's a chart showing the continued decline in the rate at which human economic activities are adding carbon dioxide to the Earth's atmosphere.

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 2000 - November 2021

Since December 2019, a net reduction of 0.74 parts per million of atmospheric carbon dioxide has been recorded in the trailing twelve month average of the year over year rate of change in atmospheric carbon dioxide levels measured at the remote Mauna Loa Observatory. We estimate this change represents a net loss of $24.6 trillion to the world economy since the coronavirus pandemic originated in China at this time. Approximately a third of that decline has taken place since July 2021.

Meanwhile, on Mars, economic output has hit an all time high, but that's mainly because the red planet's GDP is now greater than zero. More on that story here from your sole source of planetary scale economic reporting!

References

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. [Text File]. Updated 6 December 2021. Accessed 6 December 2021.

Previously on Political Calculations

Here is our series quantifying the negative impact of the coronavirus pandemic on the Earth's economy, presented in reverse chronological order.