{"id":6852,"date":"2022-07-19T00:00:00","date_gmt":"2022-07-19T00:00:00","guid":{"rendered":"https:\/\/www.nextias.com\/current_affairs\/uncategorized\/19-07-2022\/yield-inversion-soft-landing-and-reverse-currency-wars\/"},"modified":"2022-07-19T00:00:00","modified_gmt":"2022-07-19T00:00:00","slug":"yield-inversion-soft-landing-and-reverse-currency-wars","status":"publish","type":"post","link":"https:\/\/www.nextias.com\/ca\/current-affairs\/19-07-2022\/yield-inversion-soft-landing-and-reverse-currency-wars","title":{"rendered":"Yield inversion, Soft-landing and Reverse Currency wars"},"content":{"rendered":"<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>In News<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">Recently, with the US inflation rate at 9.1%, the highest in 40 years, it is significant to take a look at these key terms.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Background<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Inflation in the US<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: the inflation rate for June came in at 9.1 per cent. This is the highest in 40 years in the US.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">There is a rapid increase in interest rates by the US central bank.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Inversion of the US yield curve<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: it is to argue that the US central bank will not be able to achieve a soft-landing for the economy.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">Yet the US dollar continues to gain against all other currencies.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Reverse currency war<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: most central banks across the world are trying to raise their interest rates to counter the Fed\u2019s actions and ensure their respective currency claws back value against the dollar.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Bond yield curve inversion<\/u><\/strong><\/span><\/span><\/span><\/p>\n<p style=\"text-align:center\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><img decoding=\"async\" src=\"https:\/\/lh5.googleusercontent.com\/ghu-jWZ8vikSpYp271IdBiV5Cxi6bHbYFAZ2CoS-T6HN_tRXDfDZr1TmAPfC7hJPthzn4aTWLmWhQr5y4VlSpl4sIBbEUZd_KaFDGih0tYdIACotm8oe3th0UcavQ-VXdDEtpAwXayxkzvIBMHQ\" style=\"height:303px; width:412px\" \/><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Bonds are essentially an instrument<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> through which governments (and also corporations) raise money from people.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Risk-free interest rate<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: Typically government bond yields are a good way to understand the risk-free interest rate in that economy.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>The yield curve is the graphical representation of yields from bonds over different time horizons.<\/strong><\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">In other words, if one was to take the US government bonds of different tenures and plot them according to the yields they provide, one would get the yield curve.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Under normal circumstances<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: any economy would have an upward sloping yield curve. That is to say as one lends for a longer duration or as one buys bonds of longer tenure one gets higher yields.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">If one is parting with money for a <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>longer duration the return should be higher.<\/strong><\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>A longer tenure<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> also implies that there is a <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>greater risk of failure.<\/strong><\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Inverted curve<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: bonds with tenure of 2 years end up paying out higher yields than bonds with 10 year tenure. Such an inversion of the yield curve essentially suggests that <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>investors expect future growth to be weak.<\/strong><\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">When <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>investors feel buoyant<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> about the economy they <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>pull the money out from long-term bonds<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> and put it in short-term riskier assets such as stock markets.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">In the bond market the <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>prices of long-term bonds fall, and their yield rises<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">This happens because <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>bond prices and bond yields are inversely related<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Implications of Bond yield curve inversion<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Pull out money<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: When investors suspect that the economy is heading for trouble, they pull out money from short-term risky assets such as stock markets and put them in long-term bonds.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">This causes the <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>prices of the long-term bonds to rise and their yields to fall.<\/strong><\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Strong predictor of recessions<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: inversion of the bond yield curve has become a strong predictor of recessions.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">Such inversion is happening repeatedly in the US suggesting many that a <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>recession is in the offing.<\/strong><\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Currently, the US Fed has been raising short-term interest rates<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> which further bumps up the short-end of the yield curve while <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>dampening economic activity<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Soft-landing<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Increasing the interest rate<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: The process of monetary tightening that the US Fed is currently unveiling involves not just reducing the money supply but also increasing the cost of money that is the interest rate.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Soaring inflation<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: The Fed is doing this to contain soaring inflation. Ideally, the Fed or any central bank doing this would like to bring about monetary tightening in such a manner that slows down the economy but doesn\u2019t lead to a recession.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Soft-landing versus hard-landing<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: When a central bank is successful in slowing down the economy without bringing about a recession, it is called a soft-landing in which no one gets hurt.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">But when the actions of the central bank bring about a recession it is called a hard-landing.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Implication of Soft-landing<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Fears of hard-landing<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: Given the massive gap between the current US inflation rate over 9% and the Fed\u2019s target inflation rate 2%, Experts expect that the Fed would have to resort to such aggressive monetary tightening that the US economy will end up having a hard-landing.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Reverse Currency War<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Investment and Dollar becoming stronger<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: A flip side of the US Fed\u2019s action of aggressively raising interest rates is that <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>more and more investors are rushing to invest money in the US<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">This has made the <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>dollar become stronger than all the other currencies<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">. That\u2019s because the dollar is more in demand than yen, euro, yuan etc.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Currency war<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: In the past the US has often accused other countries of manipulating their currency and keeping its weaker against the dollar just to enjoy a trade surplus against the US. This used to be called the currency war.<\/span><\/span><\/span><\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Every central bank today <\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">is trying to figure out ways to counter the US Fed and raise interest rates themselves in order to ensure their <\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>currency doesn\u2019t lose too much value<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"> against the dollar.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:13pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong><u>Implications of Reverse Currency War<\/u><\/strong><\/span><\/span><\/span><\/p>\n<ul>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>Exports<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: this should make all other countries happier because a relative weakness of their local currency against the dollar makes their exports more competitive.<\/span><\/span><\/span>\n<ul>\n<li style=\"list-style-type:circle\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">A Chinese or an Indian exporter gets a massive boost.<\/span><\/span><\/span><\/li>\n<\/ul>\n<\/li>\n<li style=\"list-style-type:disc\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\"><strong>A stronger dollar has had a key benefit<\/strong><\/span><\/span><\/span><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">: importing cheaper crude oil. A currency which is losing value to the dollar on the other hand finds that it is getting costlier to import crude oil and other commodities that are often traded in dollars.<\/span><\/span><\/span><\/li>\n<\/ul>\n<p><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#000000\">Source: <\/span><\/span><\/span><a href=\"https:\/\/indianexpress.com\/article\/explained\/yield-inversion-soft-landing-reverse-currency-wars-explained-8035759\/\" style=\"text-decoration:none\" target=\"_blank\" rel=\"noopener\"><span style=\"font-size:12pt\"><span style=\"font-family:'Book Antiqua',serif\"><span style=\"color:#1155cc\"><u>IE<\/u><\/span><\/span><\/span><\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>In News Recently, with the US inflation rate at 9.1%, the highest in 40 years, it is significant to take a look at these key terms. Background Inflation in the US: the inflation rate for June came in at 9.1 per cent. This is the highest in 40 years in the US. There is a [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":6853,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[21],"tags":[26],"class_list":["post-6852","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-current-affairs","tag-gs-3"],"acf":[],"jetpack_featured_media_url":"https:\/\/wp-images.nextias.com\/cdn-cgi\/image\/format=auto\/ca\/uploads\/2023\/07\/4284484Screenshot_6.png","_links":{"self":[{"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/posts\/6852","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/comments?post=6852"}],"version-history":[{"count":0,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/posts\/6852\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/media\/6853"}],"wp:attachment":[{"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/media?parent=6852"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/categories?post=6852"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.nextias.com\/ca\/wp-json\/wp\/v2\/tags?post=6852"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}