Saturday, July 28, 2018

Cost of car ownership vs Cost of Taking Taxi in Singapore

The cost of car ownership in Singapore is renowned to be the most expensive in the world. To put it into perspective, for every 1 Honda Jazz that you buy in Singapore, you can buy 3 in the UK. The reason why Singapore has such high cost for car ownership is because of our small size. Due to limited space, our government wants to maintain the vehicle population at levels supportable by road infrastructure. It wouldn’t be nice to be caught in a Jarkata-liked traffic jam where being in traffic for four hours is not unusual. For this post, my purpose is to find out if it is still worth owning a car in Singapore as compared to taking a taxi for all my commute? I have excluded the comparison of other mode of transport such as Bus or MRT which of course would be cheaper but might be less comfortable and convenient.    

To answer my question, I will first have to find out all the different components that make up the car prices in Singapore, then its financing cost followed by all its day to day running expenses. Next I will calculate the average price of taking a Taxi based on the same mileage per year to make apple to apple comparison. And as the running expenses of car also depends heavily on one's personal lifestyle, my calculation will be based on two extreme situation that will have a huge difference in the cost- people who work in CBD and people who are not.    

The Car Model that I am going to use for my calculation is a Honda Jazz 1.5 CVT (Honda Jazz) as this is an average family car that is not considered no expensive as compared to the others. Also my calculation is for a period of 10 years as that is when the Certificate of Entitlement (COE) expire.
Cost of Car
The components that make up the cost of car in Singapore includes:
  • Open Market Value (OMV)
  • Goods and Service Tax (GST) and Excise Duty
  •  Registration Fee
  • Additional Registration Fee (ARF). If the car is deregistered before its 10th year, a PARF Rebate that is based on the ARF paid will be returned
  • Vehicle Emission Tax/Rebate
  • Certificate of Entitlement (COE)

Each of the components will be explained in more details and the cost for each component for a Honda Jazz is reflected on each component header.

Open Market Value (OMV): S$16,869

The OMV is the cost of the car that includes its purchase price, freight, insurance and all other charges to deliver it from the country of manufacture to Singapore. This cost is assessed by the Singapore Custom.

GST and Excise Duty: S$4,791
 When the vehicle is imported into Singapore, the two taxes that need to be paid is:
  • 20% Excise Duty on the OMV
  • 7% GST on the OMV and Excise Duty

Registration Fee: S$220
Upon registration of vehicle, this fee will be collected to cover the costs of registering the vehicle

Additional Registration Fee (ARF): S$16,869
The ARF is another tax that is imposed on the registration of the car and is based on the car’s OMV. From table 1, you can see that the ARF effectively inflate the cost of the car by at least 100% of its OMV.

As the OMV of Honda Jazz is less than $20,000, its ARF is 100% of its OMV.

Table 1: ARF Rate (Source: LTA)
Vehicle OMV
ARF Rate
First S$20,000
Next S$30,000
(i.e. S$20,001 to S$50,000)
Above S$50,000

Vehicular Emissions Scheme (VES): S$0
Depending on how clean or polluting the car is, a rebate/tax ranging from $0 to $20,000 can be offset or levied on the ARF (subject to a minimum ARF payable of $5,000). The VES is a tax that is based on the vehicle’s emission of 5 pollutants. If you are interested to know, they are hydrocarbons (HC), carbon monoxide (CO), nitrogen oxides (NOX) particulate matter (PM) and Carbon Dioxide (CO2). In this case, the Honda Jazz is assessed to be neither clean nor polluting, therefore there is no additional rebate given or tax incurred.

Certificate of Entitlement (COE): S$35,000
With a COE, it gives you the right to own a vehicle for 10 years and this is used by our government to control the car population in Singapore through bimonthly competitive bidding. So if there are more cars deregistered in Singapore, there will be more supply of COE which might results in lower COE price and vice versa. The Honda Jazz is under COE’s CAT A as it has an engine capacity (cc) of less than 1600cc. At the latest bidding (18 July 18), the COE premium is $32,700. I will round this up to $35,000 for simplicity calculation. 

To sum up the above cost components, a Honda Jazz cost price in Singapore is S$73,749. However, car dealers who are selling the car also needs to make a profit. Therefore the list price based on COE of $35,000 is $96,000.

Total Purchase cost: S$96,000

Financing Cost: S$14,112
Right at this stage, the cost of a car is $96,000 even before you even start driving. In order to purchase it, we might need help from the bank to finance this purchase. This will incur additional finance cost. 

As Singapore government does not want us to be over leveraged, they have set a limit on how much  car loan we can take.

  • For car with OMV below $20,001, maximum loan value will be 70% of the car price
  •  For car with OMV above $20,000, the maximum loan value will be 60% of the car price
Furthermore, the maximum loan term allowed is 7 years. As such, the down payment will be $28,800 with the remaining $67,200 being financed by a bank loan. Based on an interest rate of 3%, the total interest paid for 7 years will be $14,11 (The monthly principal and interest repayment is $968).

Preferential Additional Registration Fee (PARF) Rebate: -S$8,435
At the end of the car 10th year, we can decide to de-register the car or renew its COE. If the car is de-registered, a PARF rebate that is computed based on the age of the car at deregistration (as shown in table 2) will be paid back. This scheme is to encourage timely replacement of cars on Singapore road to ensure better road safety and cleaner environment.

Table 2: PARF Rebate (Source: LTA)
Age at Deregistration
PARF Rebate 
Not exceeding 5 years
75% of ARF paid
Above 5 but not exceeding 6 years
70% of ARF paid
Above 6 but not exceeding 7 years
65% of ARF paid
Above 7 but not exceeding 8 years
60% of ARF paid
Above 8 but not exceeding 9 years
55% of ARF paid
Above 9 but not exceeding 10 years
50% of ARF paid
Above 10 years

Assuming the Honda Jazz is de-registered at the last day of it 10th year, the PARF rebate will be 50% of its $16,869 ARF paid previously. Therefore the rebate will be $8,435.

Car Running Expenses
There are other cost that will be incurred on a daily/yearly basis such as:

·         Road Tax
·         Fuel
·         Parking Fees
·         ERP
·         vehicle maintenance
·         Insurance

Road Tax: S$683/year
Road tax needs to be paid biannually and this is dependent on the engine capacity (EC) of the car. The formula for calculating road tax is as follow:

Table 3: Road Tax Rate (Source: LTA)
Engine Capacity (EC) in cc
6-Monthly Road Tax Formula
EC < 600
S$200 x 0.782
600  < EC < 1,000
[S$200 + S$0.125(EC - 600)] x 0.782
1,000 < EC < 1,600 
[S$250 + S$0.375(EC - 1,000)] x 0.782
1,600 < EC < 3,000
[S$475 + S$0.75(EC - 1,600)] x 0.782
EC > 3,000
[S$1,525 + S$1(EC - 3000)] x 0.782

A Honda Jazz has an EC of 1,498. As such, the yearly road tax is:

[S$250 + S$0.375(1,498 - 1,000)] x 0.782 x 2 times = $683/year

Fuel Cost: $2,318/year
In order to calculate the cost of fuel, we will first need to know the yearly average mileage of a car and its fuel consumption. In Singapore, the average passenger car travels 18,000km per year. The fuel consumption of a Honda Jazz is 5.6L/100km. Therefore the total fuel consumption per year is 1008L. Based on current petrol price of $2.30/L, this works out to be $2,318 per year.  

Parking: S$3,564/year or S$6,564/year
If you are staying in a HDB, the monthly season parking cost will be $110/mth. Furthermore if you work in the Central Business District (CBD), the season parking charges can be more than $350/mth. Otherwise it may just cost well over $100/month. 

I will also assume that some may be out during the weekend and therefore have to park at various location. The estimate for weekend parking is $20/weekend and this comes up to $87/mth. 

Annual Parking (non CBD) = ($110/mth + $100/mth + $87/mth) x 12 mths = $3,564
Annual Parking (in CBD) = ($110/mth + $350/mth + $87/mth) x 12 mths = $6,564     

ERP: S$364/year or S$1,716/year
For people working in CBD, their ERP charges can be as high as $6/weekday. This translate to $1,560/year.

There are also ERP charges on every Saturday and I will assume a cost of $3/Saturday which equals to $156/year.

I will also make assumption that those who are not working in the CBD may want to travel twice every week during the evening into CBD for leisure purposes such as having dinner. This will be $2/weekday or $$208/year.

For people not working in CBD, I will assume every 2 weekdays they have to travel to city to meet up with friends for dinner at $2/weekday. This will cost $208/year.

A new ERP system will be introduced in 2020 that has island wide coverage and charged based on distance travelled. This might result in higher ERP charges in the future.

Annual ERP (non CBD) = $208/year + $156/year = $364
Annual ERP (in CBD) = $1,560/year + $156/year = $1,716  

Maintenance: S$650
Cars in Singapore are required to go for biennially inspection when it reached 3 years of age to ensure it is roadworthy. Therefore regular maintenance is to be done before the inspection. In Singapore, vehicle maintenance cost can range from $500 to $800 per year. We will take the average of the two. 

Insurance: S$1,800/year
Vehicle insurance is compulsory in Singapore. Based on vehicle insurance quote found online, an average coverage will cost around $1,800/year. If you are a safe driver and does not make any claim for a year or more, you are entitled to a No-Claim Discount (NCD) and it can be as high as 50% if you did not claim for more than 5 years. For my calculation, I will exclude the NCD. 

Table 4: No-Claim Discount Rate (Source: AIG)

Other miscellaneous: $300/year
There may be other occasional unexpected expenses such as fines or major repair. For this I will budget an additional $300/year.

Cost of Car Ownership
For all the running expenses, I have included an annual inflation of 3%. This is based on Singapore 's private road transport inflation for the past 10 years. Next the cash flow is discounted by 2.2%, which is Singapore current 10 year risk free rate. 

The net present value (NPV) of owning a car in Singapore for 10 years are estimated to be $195k for people not working in CBD (Table 5) and $239k for people working in CBD (Table 6). This works out to be $20k and $24k per year respectively. 

Table 5: Cost of Car Ownership Net Present Value(Not working in CBD)

Table 6: Cost of Car Ownership Net Present Value(Working in CBD)

Total Cost of Car Ownership : S$20,000/year or $24,000/year

Cost of Taking Taxi
Now lets compare this cost with the cost of taking a taxi. The calculation will also be based on an annual mileage of 18,000km which we have used to calculate the cost of owning a car. 

The table below is the breakdown of the Taxi Fare of ComfortDelgro, Singapore largest land Transport Company.

Table 7: Comfort Taxi Metered Fare Structure (Source: ComfortDelgro)  
Metered Fare
Taxi Components
Flag Down fare
$3.20 to $3.90
For first 1km. Depending on vehicle type
Distance Fare
Every 400m thereafter or less up to 10km
Every 350m thereafter or less after 10km
Every 45 seconds of waiting or less
Booking Fee
$2.30 to $3.30
Depending on day and time
Peak Period Surcharge
25% or 50%
Depending on day and time

With an annual mileage of 18,000km, this means the daily mileage will be 49km, enough to travel from Pasir Ris in the East to Tuas in the West. Next I will assume the commuter to take 4 trips per day, therefore each trip will be about 12km. The daily Taxi fare is calculated as follow:

Flag down fare: $15.60 per day
I will use the higher flag down fare of $3.90

$3.90 x 4 trips = $15.60

Distance Fare: $27.70 per day
First 1km is already included in flag down fare. 
I will take that the distance fare will jump $0.22 for every 350m traveled. 

Next 11km = $0.22 x 11km / 350m x 4 trips = $27.70

Booking Fee: $13.20 per day
For every trip that I make, I will book a cab for convenience sake instead of having to queue at the taxi stand. I will use the higher booking fee of $3.30.

$3.30 x 4 trips = $13.20  

Peak Period Surcharge: $8.70 per day
The peak period surcharge is based on the day and time when taking the Taxi. I will assume that 3 trips will incur a surcharge of 25% and 1 trip will incur a surcharge of 50%.

Each distance fare cost $6.90
$6.90 x 25% x 3 trips = $5.20
$6.90 x 50% x 1 trips = $3.45

Total: $8.70

Total Cost of Taking Taxi
By summing up all the taxi fare charges, the daily cost of 4 trips with a total distance of 48km came up to S$65.20 per day or $23,798 per year. This is excluding ERP charges which passengers have to pay if their taxi goes through any ERP.

To determine if the above assumption is reliable, I compared it with Comfortdelgro app estimated price from Bedok to raffles place which is about 12.8km. The price came to between $14 and $18 per trip. My price estimate is therefore within the range.   

After accounting for inflation and discount rate, the total present cost for taking Taxi will be $246,540 for 10 years, or around $25,000 per year.  

Table 8: Cost of taking taxi net present value

Total Cost of Taking Taxi: $65.20 per day or $25,000 per year

Cost of Car Ownership vs Cost of taking Taxi
To make comparison between the cost of car ownership and cost of taking taxi, first I have to remove the ERP charges from the cost of car ownership as the calculation for cost of taking taxi does not include it. After adjustment, the cost per year for each mode of transport is shown in table 9. The result has shown that car ownership is cheaper than taking Taxi. This is assuming that you are a heavy Taxi user that requires a daily trips of 4 which cover 48km/day.  

Table 9: Summary of cost of Car and Taxi
Transport mode
Cost Per Year ($)
Car (Not working in CBD)
Car (Working in CBD)
Taxi (4 trips per day)

What if 'm just a moderate commuter that does not need to travel 4 trips a day?

Not everyone will need to take 4 taxi trips per day. For example, we may just need to:
  • Take 2 trips per day during weekdays to and from work
  • Take 3 trips per day on Saturday, Sunday and Public Holiday (PH) 
with the above profile, let me calculate the annual taxi cost.

In a year, there are 249 weekdays and 116 Saturday/Sunday and PH 

Therefore the total trips made per year would be:
 249 weekdays x 2 trips + 116 weekends x 3 trips = 846 trips per year

As calculated previously, each trip cost about $16.30, therefore total cost per year is:
846 trips per year x $16.30 per trip = $13,790 per year

For a moderate commuter, the cost per year for taking Taxi is significantly lower at around $14,000. This is cheaper than owning a car which cost $19,000 per year. 

If i'm a moderate commuter, does this mean I should not get a car?

If you are a moderate commuter, taking taxi will cost less than owning a car. However, this might not be the case if COE were to drop drastically.

I will adjust my car ownership cost model taking into account:
  • COE drops to $10,000
  • Cost of fuel based on annual mileage of a moderate commuter of 10,152km (846 trips x 12km per trip) 
The result is as follow:
Table 10: Moderate commuter cost of car ownership net present value (Not working in CBD)

Table 11: Moderate commuter cost of car ownership net present value (Working in CBD)

The models show that the cost of car ownership per year will be less than $15,000 if you don't travel often to CBD or $18,000 if you do. The cost is only slightly more expensive than taking a taxi of $14,000 per year. Therefore if COE were to drop to $10,000 or below, buying a car might be a better option as the cost of car ownership and cost of taking taxi will converge greatly.

Will COE drop to below $10,000?
This is possible as shown in Table 12, COE has dropped to below $10,000 (represented by green line below the black line) during 2008 and 2009 period when the financial crisis hits.

However, it is to note that during that period, the annual vehicle growth rate allowed is 1.5%. Now it has been revised to 0%, meaning that future supply of COE will shrink greatly. Furthermore, the COE quota starts to drop in 2010 to 2015. Assuming every car owner did not renew their COE after the 10th year, this means that we could possibly see a significant drop in COE supply in 2020 to 2025. Therefore COE prices is expected to rise unless we see another major crisis like the 2007 financial crisis.

In the near term, a  monthly 3,328 COEs will be up for bidding for Category A from August to October 2018 period. This is 16% higher than last quarter quota and may be due to the exit of Uber. However, it is expected that there won't be significant changes in COE price as demand for cars are still high. This can be seen from the most recent bidding when total bids spiked after the previous round where COE dropped to $25,000, causing COE price to be back at the $32,700 level.

Table 12: COE Quotas, Bids Received and Prices (Source: SGCharts)

Personally, I dislike driving especially in Singapore. This is because firstly, your full concentration has to be on the wheel and unlike taking the public transport, you can just relax and do your own stuff. Secondly, as Singapore is a small place, the density of cars are quite high which increase the stress of driving. Lastly, you always need to find a parking space and sometimes this may take up quite a bit of your time. If I were to just take a taxi, this wouldn’t be an issue. However, if COE were to drop to below $10,000, I will seriously consider buying a car and the biggest motivation would be if I have my own family as their comfort will outweigh the other consideration.

For potential car buyers, hopefully my above analysis can help you make an informed decision and lets cross our finger to hope for a drop in COE prices! 

Saturday, July 14, 2018

Koufu Group Limted IPO

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Hawker centres and food courts are an important part of Singapore’s food culture. You go into one of the food centre and will be spoilt for choice of all the delicious local food which comes at a rather affordable price. Now would you want to own a piece of this business that all Singaporeans know about?

Koufu Group Limited, which is known for their food courts, has lodged its prospectus with Monetary Authority of Singapore for its initial public offering on 18 July 2018 with the main board of the Singapore Exchange. The public offer closes at noon on 16 July 2018

Understanding its Business

Koufu is an established company in Singapore F&B and food service management industry for 16 years since 2002. They provide competitive-priced dining options and is supported by local food consumption habits and therefore, is believed to be resilient through economic cycles. It main operation is in Singapore while having a small presence in Macau. As at FY2017, 92% of its revenue is generated from Singapore while 8% is from Macau. 

The total fund to be raised is $43m and it will be intended for the following purpose:
  • ($30m or 66%) Build a larger central kitchen that is five times bigger than existing central kitchens to enhance productivity and operational efficiency. Also with spare capacity, they could utilise it to manufacture and supply semi-finished or finished food products to stall operators as well as third party businesses, providing another source of revenue
  • ($8m or 18%) Refurbish and renovate existing F&B outlets in order to maintain the suitability of use and encourage repeated patronage
  • ($5m or 11%) Expand and strengthen their presence with new F&B outlets in Singapore and overseas with a focus on hospitals, commercial malls, tertiary educational institution and new housing estates. Their current plans was to open 1 food court at Sengkang General and Community Hospital, 2 new food courts in Tampines and Bukit Batok. They also intend to expand their overseas footprint with an initial focus on Macau.
  • Joint venture opportunities such as investing in a business to business bakery to expand into the bakery, confectionary and hot kitchen food production business.
  •  Roll out online food ordering and delivery services to most of their F&B outlets
As stated in its prospectus, Koufu business is separated into 2 main segments- outlet & mall management (O&M) and F&B retail business. Each business segment represents roughly 50% of Koufu FY2017 revenue.

O&M Business- Under its O&M business, Koufu operates and manages:
  • 47 food courts (Singapore)
  • 14 coffee shops (Singapore)
  • 1 hawker centre (Singapore)
  • 1 commercial mall - Punggol Plaza (Singapore)
  • 1 food court (Macau)
Below are the brands that Kofu currently operates.

Related parties transactions

The existing corporate structure is shown as below. Koufu main shareholder is Jun Yuan Holdings Pte Ltd ("Jun Yuan"), owned wholly by Mr. Pang Lim and Mdm. Ng Hoon Tien, who is also the executive director of Koufu. 

Prior to the listing, these are some of the transactions that took place that might be of interest to investors:

·         28/9/17 - Koufu sold a property with net book value of $357k to Jun Yuan
·     28/9/17 – Koufu sold 1 food court and 5 coffee shops to Jun Yuan. This was rented back to Koufu at a current rate of $268k/mth. The rental will be renewed every 4 years and the rental rate will be determined by an independent valuer with Koufu having to pay either (a) at the market rental value, or (b) at a rental below the market value. 
·    The amount paid by Jun Yuan to Koufu was subsequently returned back to Jun Yuan via a dividend payout in FY2017.

Due to the above transactions, Koufu total assets has dropped by 42%, from $187m in FY2016 to $107m in FY2017. As the transaction took place prior to listing, this will not affect my assessment of its valuation. However, there might be some impact from the "sales and leaseback" agreement of the 1 food court and 5 coffee shops with Jun Yuan as it is on a recurring basis. This transaction might result in a 2.5% increase in property rental expenses (from $95.9m to $98.3m) for FY2018, assuming the properties were owned by Koufu previously with no rental payment needed.

After the IPO, Jun Yuan will continue to hold 78.7% of the company while conerstone investors will own 3.8% of the company. It is to note that cornerstone investors are not subjected to any lock-up restriction in respect of their shareholding interest. This means they are free to sell their shares on the 1st day of trading. 

Financial Performance

Based on FY2017, Koufu growth has been quite stagnant at CAGR of 2.94% for the past 3 years whereas Kimly was at 7.2%. However Koufu was more profitable with gross and profit before tax margin higher than  Kimly. Koufu staff cost was also way lower than Kimly with staff cost/revenue at 17.16% as compared to Kimly 26.15%. This means that for every $1 of revenue generated, Koufu only need to spend staff cost of 17cents as compared to Kimly 26cents.  


As compared to peers with similar size in terms of market capitalization and after adjusting* its balance sheet and profit and loss statement taking into account the transactions listed in Related Party Transactions section, Koufu PE ratio of 14.38c and price/NTA per share of 4.85x seems to suggest its valuation of $0.63 per share is cheaper than Kimly and much cheaper as compared to Jumbo. If it were to trade at the same valuation as Kimly, its share price will be $0.815 based on Kimly PE ratio and $0.685 based on Kimly Price/NTA per share. A potential appreciation of 29% and 8.7% respectively above its offering price of $0.63.

Koufu has suggested a dividend payout of at least 50% of net profits after tax generated in FY2018 and FY2019, this translate to an annual dividend of 3.4% based on the above adjusted profit after tax.


Koufu seems to be rightly priced and looks attractive to invest in a cash generative business.

Its future growth and risk depends on:
  • The future central kitchen in improving their margins and generating alternative source of revenue from its spare capacity 
  • Success of local and overseas expansion  
However, some of its related party transactions that was done prior to IPO still bug me as I feel it may be detrimental to future shareholder. Furthermore, the existing weak investment market coupled with the lack of lock-in for cornerstone investors heighten the risk of a disappointing IPO.

My take on this IPO is neutral. For interested investor, you still have 2 days to ponder on!

Tuesday, May 15, 2018

Is the Yield Curve predicting another Financial Crisis?

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The yield curve has predicted seven out of seven recession in the past 50 years, a perfect forecasting track record. It is no wonder investors are concerned when looking at the current yield curve as it seems another recession is looming.

Explaining the Yield Curve
A yield curve in a graph shows the relationship of different bonds' interest rates of similar risk but with different maturity date. On the x-axis, it is the maturity date of the bond while on the y-axis, it is its interest rate. For the purpose of illustration, we will use US Treasury bond as it is perceived as risk free due to it being backed by the USA government.

Every bond has an interest rate that shows the return required by the investor who wants to invest in it. For example, USA 10-year Treasury bond is currently at 3%. This means that investor who bought the bond will receive 3% return every year for the next 10 years. Interest rates usually reflects the risk of the investment. For example, higher interest rate means higher risk and vice versa.

Generally, a long term bond will have a higher interest rate as compared to a short term bond. This is due to the thinking that because you are committed to invest longer, there is higher chance of you losing the money and therefore higher risk. During normal economic condition when investor expect economy to grow at normal pace, short term bond interest rate will be lower than long term bond interest rate, resulting in a positive yield curve as shown below.

Positive Yield Curve

The positive yield curve can steepen, meaning that long term bond interest rate rise faster than short term bond, and this usually happen during bullish market condition. In a bullish economic environment, companies are expected to do well and may proceed with their expansion plan. This will result in lower unemployment and rising wages. There is also ample liquidity in the market as banks are willing to lend money to consumer and companies to spend and invest at low interest rate. The increase wealth will results in higher consumption. This increased demand for limited supply of goods will result in higher inflation.

Inflation is not good for investors who wants to invest in long term bond. This is because if inflation is expected to increase faster, holding on to long term bond will result in lower net interest return. To illustrate, today you invest in a 10 year 3% bond with current inflation of 1%. Your net return is 2% by the end of year 1(3% - 1% = 2%). Say 5 years down the road, if inflation accelerated and hit 5%, your net return will be -2% (3% - 5%= -2%). Therefore in an inflationary environment, demand for long term bond will decrease and in order to entice people to buy long term bond, its interest rate has to increase so that it will provide sufficient return to the investors.

For investors investing in short term bond, accelerating inflation will not impact them greatly as their bond will mature in a matter of months and by then, they can reinvest their capital into higher yielding bonds if the opportunity arises. Short term bond investor would therefore be less demanding on requesting for very high interest rate. So during bullish economic condition, long term bond yield will expand at a faster rate than short term bond resulting in a steepening of the positive yield curve.

Inverted Yield Curve

With expected higher inflation, central banks will start to increase its interest rates so that it will make it more expensive for people and companies to borrow money, thus curbing inflation. This will cause economic environment to slow down. With the view that market condition has become more uncertain with risk of recession, bond investors will start to turn their investment into long term bond. The reason is it provide a safe place for investors to put their money in amid falling equities markets and volatile environment. As long term bond interest rate is currently high, investors will want to lock in the high yield before they decrease further. As demand for long term bond increase, investors will be less demanding on the interest rate and therefore it will start to fall. This may result in long term bond yield falling below short term bond yield, forming an inverted yield curve.

Well you may ask who would want to invest in a 10 year Treasury bond that give a lower interest as compared to a 2 year Treasury bond. Let me illustrate with the following example:

Assuming today is 4th of July 2000 with the 2 year Treasury bond and 10 year Treasury bond at 6.38% and 5.86% respectively. Also assuming that after your 2 year Treasury bond mature, you will reinvest it in another 2 year Treasury bond at the interest rate at that point of time. Even though the 10 year Treasury bond has an initial lower interest than 2 year Treasury bond in year 1, over the course of 10 year, the return for 10 year bond is higher as investor has locked in the higher interest rate already.

Historical Trend

An inverted yield curve usually signal a recession is on the horizon. In the past, the US Treasury yield curve inverted before past recessions such as the 1981 and 1991 recession, dot-com bubble in 2000 and the global financial crisis in 2008. The graph above shows the difference between 10 year US Treasury bond interest rate and 2yr Treasury bond interest rate. When the blue line is below the grey line of 0, it means 10 year bond interest rate is lower than 2 year bond interest rate, which also means an inverted yield curve. As we can see the inverted yield curve is subsequently preceded by recessions which is represented by the background highlighted in grey.

Also from the graph, we can see that there is a lag between the negative spread before the onset of the recessions. During the 2008 global financial crisis, 3 months after the spread turned into sustained positive territory from negative, the Dow Jones Industrial Average starts its slide into bear market. As for during the dot com bubble, it happened after 5 months from the onset of sustained positive spread.

Current Trend

Currently, the difference between 10 year and 2 year Treasury bond is at positive 0.5% but continue to trend downwards. This is in spite of 10 year Treasury bond yield having continued to rise and touched 3% but short term bond is rising at an even faster rate. Are we heading for another inverted yield curve and subsequent recession or will this time be different? We shall see.