Research topic: yield curve inversions

Introduction

An inverted yield curve occurs when long-term yields fall below short-term yields. Under unusual circumstances, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. An inverted curve has indicated a worsening economic situation within 9 to 18 months in the future 5 out of 6 times since 1970. The signal-to-noise ratio of the yield curve in predicting recessions is very high and is in fact used by the US Federal Reserve as one of the indicators for their policies. In addition to potentially signaling an economic decline, inverted yield curves also imply that the market believes inflation will remain low. This is because, even if there is a recession, a low bond yield will still be offset by low inflation. However, technical factors, such as a flight to quality or global economic or currency situations, may cause an increase in demand for bonds on the long end of the yield curve, causing long-term rates to fall. This was seen in 1998 during the Long Term Capital Management failure when there was a slight inversion on part of the curve.

In the United Kingdom pension funds and mutual funds tend to buy a higher proportion of longer dated bonds creating yield pressures compared to their counterparts elsewhere. Hence yield curve inversions tend to occur more often without necessarily signaling a recession for the UK economy in the years ahead. Also the maturity of these bonds is 30 years or longer, diluting the predictive power of the yield curve over such periods.

Requirement

In this research project, an analyser of yield curves needs to be built. This means that an online database engine needs to be set up that will retrieve, store and analyse bond yields of different maturities and different countries. Yield curves should be displayed graphically. The following inferences should be made:

  1. What are the fundamental market conditions under which yield curve inversions emerge?
  2. Are some countries more prone to yield curve inversions than others, such as in the example in the introduction, and what are the underlying determinants?
  3. Under what conditions do yield curve inversions conclude?

Profile of candidate

The following planning is proposed, each is expected to last about 1 month:

  1. Research solution and identify options for development : draft project proposal, investigate options for solution implementation including testing guidelines and storage guidelines.
  2. Develop and implement solution, including half term presentation.
  3. Write final report, including final presentation.

Knowledge of macro-economics a plus.

Introductory knowledge of mathematical statistics a plus.

Terms and conditions

The internship needs not be developed at the office, but can be performed at the university.

An internship reimbursement is applicable.

This project is expected to last 3 months. Although full time availability is recommended, this is not a strict requirement and availability of 3 days or more per week is acceptable. The candidate should be able to manage his/her own time and regularly update Hobury on progress and issues. Both an intermediate (half term) and a final presentation will be part of this internship assignment.

Copyright of the solution remains with Hobury.