The melody of a yield curve

This is an audio transcript of the FT News Briefing podcast episode: The melody of a yield curve

Joanna S Kao
Good morning from the Financial Times. Today is Monday, December 20th, and this is your FT News Briefing.

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In today’s episode, we’re going to listen to yield curves. Investors pore over these charts of US government bond yields to find out where the world’s biggest economy is headed. What can we learn by listening to them?

Tommy Stubbington
Broadly speaking, going up is good news, or at least a kind of. We’re living in a normal world. Flat, you’re hearing some cause for concern, and then descending is a flashing warnings on.

Joanna S Kao
Our capital markets correspondent Tommy Stubbington will be our musical guide. We’ll also look at new Covid restrictions in Europe and how a battle in US congress over Biden’s latest spending bill will affect millions of families. I’m Joanna Kao in for Marc Filippino, and here’s the news you need to start your day.

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Omicron is spreading across Europe and countries are moving to try to contain it. The Netherlands has imposed a nationwide lockdown, the strictest of any European country, but all are under pressure from scientists to act. Germany now has new requirements for visitors, including a 14-day quarantine, regardless of vaccination status. Ireland will have an 8pm curfew for pubs and restaurants. Britain’s health minister said he would give no guarantees that he would not order a pre-Christmas lockdown.

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In the US, a key senator said he will not vote for Joe Biden’s latest spending package. West Virginia Democrat Joe Manchin is rejecting the Build Back Better bill, in part because of the unclear cost of a childcare benefit. The FT’s Taylor Nicole Rogers has been speaking to people who rely on the childcare checks, and she says it’s made a huge difference in low income communities.

Taylor Nicole Rogers
It’s cut child poverty dramatically. We saw in the figures this year that poverty has gone down, which you don’t expect to see when you’re in the middle of a crisis. But advocates say its bills like this that have really allowed parents to financially care for their children despite school closures, despite people being out of work. One of the mothers I spoke to said, you know, it’s really unfortunate that this is ending when it is because of inflation, because taking care of children is getting more expensive and because everything in New York is shutting down again because of Omicron. So as the way she said it, Covid’s not gone yet.

Joanna S Kao
That’s Taylor Nicole Rogers, the FT’s labour and inequalities correspondent.

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One of the biggest financial markets in the world is the one for US government bonds. Investors watch the US treasury market for clues as to where the US economy is headed. What they watch is the yield curve. This is a chart that shows interest rates from short-term to long-term bonds,

Tommy Stubbington
Typically in a normal economy, let’s say a healthy economy, you’d expect that line to slope upwards. You’d expect short-term interest rates to be lower than long-term interest rates. Now, that’s because, you know, investors are always likely to demand a higher rate of interest to compensate them for the greater uncertainty of lending their money for decades as opposed to days or weeks. That’s in a normal healthy market.

Joanna S Kao
That’s the FT’s capital markets correspondent Tommy Stubbington. He says the yield curve is the next best thing to a crystal ball, and the yields are not about risk.

Tommy Stubbington
We’re talking about the safest borrower in the world here really, we’re talking about the US government, you’re going to get paid back. So different borrowing rates, they’re not telling you anything about credit risk. They’re not telling you anything about the risk of getting your money back. Really, what they’re telling you is about the prospects for growth and for inflation of interest rates over different periods of time. So what it means is the yield curve effectively adds up to a sort of predictive device for where all of those things are going to be over different periods.

Joanna S Kao
Tommy concedes it’s hard to understand. Fortunately, the FT’s Alan Smith, head of visual and data journalism, turned US yield curves into notes and melodies. So instead of talking about lines and dots on charts now, Tommy can describe what you’re hearing.

Tommy Stubbington
So in terms of how this translates into music, a lower interest rate will be a lower note and a higher interest rate will be higher note. So what you hear when we have, as I say, a normal upward sloping yield curve is a gently rising series of notes. When we’re talking about a flat yield curve, it’s a bunch of notes that are roughly the same pitch.

[YIELD CURVE MUSIC PLAYING]
Then an inverted curve, you’ll actually hear the pitch descending.

[YIELD CURVE MUSIC PLAYING]

Joanna S Kao
It’s kind of a dip. And that’s bad news, right?

Tommy Stubbington
That is bad news. I mean, as I say, it’s typically been a pretty accurate predictor of recessions. I should add that the yield curve isn’t inverted at the moment. It’s flattened quite a bit, but it is still upward sloping.

Joanna S Kao
Going back to predicting recessions, let’s listen to the yield curve just before the 2008 recession. So this is a series of yield curves starting in 2007.

[YIELD CURVE MUSIC PLAYING]

Tommy Stubbington
What you’re hearing here is a series of notes, all at roughly the same pitch, which tells you basically that the yield curve at this point is fairly flat. Now a flat yield curve typically tells you that the market is signalling that an economic slowdown is on the way. It means the long-term borrowing costs, long-term interest rates are at roughly the same level as the short-term interest rates, which tells you that you know investors maybe see trouble around the corner.

Joanna S Kao
So it’s in early 2007 where you can see or hear the yield curves starting to predict what’s going to happen the following year. The notes are dipping down at the start of the curve, and this is when short-term interest rates rose higher than rates for long-term treasuries.

[YIELD CURVE MUSIC PLAYING]

Tommy Stubbington
That tells us that the yield curve is inverted, as we say. Now what that basically tells you is the market is expecting interest rates to be cut. And typically, it’s expecting interest rates to be cut because it’s expecting something bad to happen to the economy.

Joanna S Kao
Which is exactly what happened. Let’s jump to more recent times. This is the yield curve starting in 2018 through fall of 2019. And you can hear it flatten and then invert.

[YIELD CURVE MUSIC PLAYING]

That’s the sound of short-term Treasury yields rising above long-term yields. That happened in September 2019. On the chart the line dips down and looks like a shallow depression.

Tommy Stubbington
That’s the market basically telling us an economic slowdown is ahead. And when you have the inversion, then it’s actually going down, that’s the market telling you that it expects a recession and this is where we got to in 2019. Now, of course, we did get a recession in 2020, but that was because the Covid pandemic arrived. Now, I don’t think even the most avid proponents of the yield curve would claim that investors collectively knew that the pandemic was coming. But in any case, we did get a recession, so I suppose in one sense that the track record of the yield curve was was preserved.

Joanna S Kao
Thanks to Covid the yield curve’s 50-year track record of predicting recessions was preserved. A silver lining, for sure. So let’s end with the melody this past year.

Tommy Stubbington
It’s interesting. It’s been a pretty fast turnaround at the start of this year. At the start of 2021, people were anticipating this roaring recovery as economies exited the pandemic. Now we’re at a point where central banks are having to raise interest rates to contain very, very high inflation. But at the same time, people are much more concerned about the longer term outlook for growth. What that has meant is that the yield curve has flattened again. And I suppose what investors collectively are telling us here is that this economic cycle, this period of recovery after the pandemic, might be quite a short one. We might end up back in another downturn, possibly not that long after the recovery began.

Joanna S Kao
Tommy, you look at yield curves all the time. So what did you think when you first heard yield curves turned into sound?

Tommy Stubbington
I mean, I think this is, this is such an important underpinning of so much of financial markets, but it’s this kind of abstract thing that’s difficult for, you know, normal people that don’t look at bond yields all day to get their head around. And one way of making it clear to people is by setting it to music.

Joanna S Kao
That’s the FT’s capital markets correspondent Tommy Stubbington.

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You can read more at all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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