What is an Inverted Bond?

Bond market predicts a recession ahead

Inverted bond chart, also known as the yield curve inversion, is a powerful economic indicator that has garnered significant attention in recent years. In simple terms, an inverted bond chart is when the yield on short-term bonds exceeds the yield on long-term bonds. This event is considered a warning sign of an impending economic recession. In this article, we will explore what an inverted bond chart is, how it works, and what it means for investors.

What is an Inverted Bond Chart?

A bond is essentially an IOU issued by a borrower, such as a company or a government, to an investor. The bond pays interest to the investor at a certain rate, also known as the yield. The yield on a bond is determined by the prevailing interest rates in the economy and the creditworthiness of the borrower. Generally, the longer the maturity of the bond, the higher the yield investors demand. This is because investors demand a premium for lending their money for a longer period, as there is more risk involved.

An inverted bond chart is when the yield on short-term bonds exceeds the yield on long-term bonds. This is a rare occurrence and happens when investors lose confidence in the economy’s future prospects. Normally, investors expect to receive a higher yield on long-term bonds because they are taking a greater risk by lending their money for a longer period. However, when investors are worried about the economy’s prospects, they demand higher yields on short-term bonds as they are more concerned about the immediate future. This demand for short-term bonds drives down their yields and causes the yield curve to invert.

How Does an Inverted Bond Chart Work?

An inverted bond chart works by reflecting the market’s expectations of future economic growth and inflation. When investors are optimistic about the economy’s future prospects, they demand lower yields on short-term bonds as they believe that interest rates will remain low in the future. This optimism drives up the yields on long-term bonds as investors are willing to lend their money for a longer period.

Conversely, when investors are pessimistic about the economy’s future prospects, they demand higher yields on short-term bonds as they believe that interest rates will rise in the future. This pessimism drives down the yields on long-term bonds as investors are less willing to lend their money for a longer period. This creates an inverted bond chart as the yields on short-term bonds exceed those on long-term bonds.

What Does an Inverted Bond Chart Mean for Investors?

An inverted bond chart is a warning sign of an impending economic recession. Historically, every recession in the United States since 1950 has been preceded by an inverted yield curve. This is because an inverted bond chart signals that investors are worried about the future prospects of the economy and are demanding higher yields on short-term bonds. This demand for short-term bonds drives down their yields and causes the yield curve to invert.

Investors should take an inverted bond chart seriously, as it indicates that the economy is likely to experience a slowdown in the near future. This can have significant implications for their investment portfolios. During a recession, the stock market tends to perform poorly, and investors may experience significant losses if they are not properly diversified. Additionally, companies may cut dividends, leading to a decrease in income for investors who rely on dividends for income.

Investors should consider adjusting their portfolios in response to an inverted bond chart. This may involve reducing exposure to stocks and increasing exposure to bonds, particularly those with short maturities. Short-term bonds are less affected by changes in interest rates and are less volatile than long-term bonds, making them a good option for investors during a recession. Investors may also consider investing in defensive stocks, such as utilities and consumer staples, as these tend to perform well during economic downturns.

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Ambac shares jump on its legal victory!

Bank of America to pay $1.84B to Ambac Financial to resolve pending lawsuits

In a regulatory filing, Bank of America (BAC) disclosed that the corporation and certain wholly owned subsidiaries entered into an agreement with Ambac Assurance Corporation (AMBC) to resolve all pending Ambac lawsuits against the corporation and its subsidiaries previously disclosed in the corporation’s Annual Report on Form 10-K for the fiscal year ended 2021, and in prior U.S. Securities and Exchange Commission reports.

As disclosed in those filings, the pending lawsuits, with damages claims of more than $3B, were brought by Ambac against Countrywide entities and other legacy entities related to bond insurance policies that Ambac provided before the 2008 financial crisis.

Under the terms of the agreement, in exchange for the corporation’s payment of $1.84B to Ambac, Ambac, among other things, will cause all pending litigation between the parties to be dismissed with prejudice, and release the corporation and its subsidiaries from all outstanding claims related to Ambac’s issuance of bond insurance policies for certain of the corporation’s and legacy entities’ securitized pools of residential mortgage loans.

The corporation previously accrued for certain amounts of the settlement payment. As a result of the previous accruals and in consideration of the settlement payment, Bank of America said it expects to incur a pre-tax expense in the third quarter of 2022 of approximately $354M, or 3c per share on an after tax basis.

Ambac had been seeking to recover billions of dollars in claims it paid out on bonds originally underwritten by Countrywide Financial, which Bank of America acquired after the mortgage firm’s collapse during the financial crisis. BofA has already paid more than $50 billion to resolve regulatory probes and litigation stemming from its $4 billion purchase of Countrywide.

A trial was underway before Manhattan Supreme Court Justice Robert Reed and was expected to last months. The eventual final payment from Bank of America will resolve all legal matters, according to the filing.

Ambac shares are up 14% to $14.55.

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Rail Traffic Declines as Growth Slows!

North American rail traffic down 1% for the week ending September 17

The Association of American Railroads, AAR, reported U.S. rail traffic for the week ending September 17. For this week, total U.S. weekly rail traffic was 490,654 carloads and intermodal units, down 2.9% compared with the same week last year.

Total carloads for the week ending September 17 were 239,528 carloads, up 2% compared with the same week in 2021, while U.S. weekly intermodal volume was 251,126 containers and trailers, down 7.3% compared to 2021.

Five of the 10 carload commodity groups posted an increase compared with the same week in 2021.

They included coal, up 3,948 carloads, to 72,774; nonmetallic minerals, up 2,491 carloads, to 35,163; and motor vehicles and parts, up 2,185 carloads, to 13,879.

Commodity groups that posted decreases compared with the same week in 2021 included metallic ores and metals, down 3,192 carloads, to 21,581; miscellaneous carloads, down 1,623 carloads, to 8,250; and forest products, down 1,362 carloads, to 9,076. North American rail volume for the week ending September 17, on 12 reporting U.S., Canadian and Mexican railroads totaled 342,034 carloads, up 3.5% compared with the same week last year, and 341,595 intermodal units, down 4.7% compared with last year.

Total combined weekly rail traffic in North America was 683,629 carloads and intermodal units, down 0.8%.

North American rail volume for the first 37 weeks of 2022 was 25,025,034 carloads and intermodal units, down 2.4% compared with 2021.

Publicly traded companies in the space include CSX (CSX), Canadian National (CNI), Canadian Pacific (CP), Kansas City Southern (KSU), Norfolk Southern (NSC), Union Pacific (UNP) and Trinity Industries (TRN), Greenbrier (GBX), FreightCar America (RAIL) and Wabtec (WAB).

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Spectrum Brands shares tumble on DOJ action

DOJ sues to block Assa Abloy deal to buy Spectrum Brands unit

On September 8th, 2021, Spectrum Brands Holdings (SPB) announced it has entered into a definitive agreement to sell its HHI segment to ASSA ABLOY (ASAZY) for $4.3B in cash, which it said represents over 14 times HHI’s expected FY21 Adjusted EBITDA. Click here to read our blog.

The U.S. Department of Justice filed a civil antitrust lawsuit today to block Assa Abloy’s (ASAZY) proposed $4.3B acquisition of the Hardware and Home Improvement division of its rival, Spectrum Brands Holdings (SPB).

Assa and Spectrum are two of the three largest producers of residential door hardware in the concentrated, $2.4 billion U.S. industry, the DOJ said.

The complaint, filed in the U.S. District Court for the District of Columbia, alleges that the merger would eliminate important head-to-head competition between ASSA ABLOY and Spectrum, risking higher prices, lower quality, reduced innovation and poorer service in the sale of at least two types of residential door hardware: premium mechanical door hardware and smart locks.

The complaint, which seeks to enjoin the transaction under Section 7 of the Clayton Act, alleges that ASSA ABLOY and Spectrum have competed for years to be leaders in the U.S. markets for premium mechanical door hardware and for smart locks.

The proposed transaction would transform these markets, giving Assa “a near-monopoly in premium mechanical door hardware and more than a 50% share in smart locks, leaving only one significant competitor,” the DOJ said.

SPB is down 10% to $52.85.

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What is FOMC’s next move?

The Fed says go, go, go, the markets’ say whoa, whoa, whoa

There is a lot of uncertainty on the Fed outlook and just how fast and how far will the FOMC go in hiking rates in orders to bring inflation down to the 2% average target.

Though Chair Powell gave no clear indication in last Wednesday’s press conference that the Fed was near done with its mission, the markets nevertheless heard what they wanted to hear, putting on a dovish spin and pricing in a pivot to rate cuts in the spring of 2023.

Fed Chair: Jerome Powell

But over the last week policymakers have been out in force, including several doves, strongly contradicting that outlook.

They have stressed the necessity of getting to restrictive territory while playing down the fear that the economy is already in recession.

Meanwhile, the U.S. ISM-NMI services index rose to 56.7 from a 2-year low of 55.3 in June that was last seen in February of 2021, translated to an ISM-adjusted ISM-NMI rise to 54.3 from a 2-year low of 53.7 in June.

Today’s rise joins big declines for the ISM, Chicago PMI, Dallas Fed and Philly Fed, but gains for the Richmond Fed and Empire State, to leave an 8-month producer sentiment pull-back from robust November peaks.

Surging interest rates and a flattening in real household spending as prices rise are aggravating the downtrend, though sentiment also faces support as businesses continue to restock.

The ISM-adjusted average of the major sentiment surveys in July fell to a 2-year low of 52 from prior lows of 53 in June and 54 in May. Analysts saw a 62 all-time high in both November and May of 2021. Analysts expect a 52 average in Q3, after averages of 55 in Q2, 57 in Q1, and 60 in Q4.

The futures are now repricing for about a 50-50 risk for a third straight 75 bp hike in September.

James Bullard
Federal Reserve Bank of St. Louis

Meanwhile, the hawk Bullard continues to look for a policy rate around 3.75% to 4% by year-end, though implied Fed funds still reflect a terminal rate in the 3.5% area.

Analysts continue to project a 50 bp boost in September followed by 25 bps in November and December to bring the median funds rate to 3.375%.

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Beige Book says housing is slowing amid high inflation

Fed’s Beige Book reiterated the economy expanded at a moderate pace

Fed’s Beige Book reiterated the economy expanded at a moderate pace.

But there was a big “however,” something the Fed typically does not express:

“several Districts reported grow signs of a slowdown in demand, and contacts in five Districts noted concerns over an increased risk of a recession.”

Most Districts reported moderation in consumer spending as higher food and gas prices diminished households’ discretionary income.

Federal Reserve Regions

Auto sales were sluggish with low inventories still impacting.

Leisure travel was “healthy.” Manufacturing was mixed. Non-financial services firms saw stable to slightly higher demand. Housing demand weakened.

As in the prior report, the outlook for future economic growth was mostly negative.

Employment generally continued to rise at a moderate pace and conditions were tight overall.

Jerome Powell, FOMC Chair

But there was some sign of modest improvement in labor availability.

Most Districts reported wage growth.

“Substantial” price increases were reported across all Districts, at all stages of consumption, with food, commodities, and energy (particularly fuel) cost remaining “significant.”

There was some moderation in construction materials.

Pricing power was steady, but firms in some sectors like travel and hospitality, were able to pass through sizeable increases to consumers. That is seen persisting through the year.

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