The term "yield curve" sounds like wonky Wall Street talk. Fortunately, the concept behind it, like many other baseball conditions, is very simple.
The yield curve is a graph that shows how much investors will get to buy short-term debt compared to long-term debt of similar quality. This is important because the shape of the yield curve has been a reliable indicator of whether an economy is in a recession.
Here's what you need to know about the yield curve and what it can mean for you:
Return curve in normal times
Let's use something familiar, like depository, to explain how the yield curve works.
If you've ever looked at prices for these scooters, you've no doubt noticed that long-term Terminella CDs pay higher interest rates than short-term CDs and traditional savings accounts. Why? The banks need to give you a little extra extra in exchange for keeping the money longer. For example, on May 1
The same thing concept applies throughout the economy and most critically in government bonds. These are the instruments that the federal government uses to borrow money and the most common debt where the yield curve is used to forecast the direction of the economy.
Here's how a normal yield curve for US government bonds looks like May 17, 2018
Source: US Treasury Department
The inverted yield curve
Now, as the malevolent Chinese curse stands in roughly translated English "you can live in interesting times."
Lately, it has been much talk about the yield curve, and that is because it behaves in unusual ways. In recent months, the traditional upward slope of the sovereign debt curve has plummeted, which means that "extra" interest rates are paid for long-term investors – the so-called "premium period" disappears. And for a short while, long-term investors became lower than the short-term investors. This yield curve is skewed downwards instead of upwards – some economists and market watchers call an inversion.
On the surface, this seems crazy. If a bank offered you a 4 percent return on a 3-month CD or 3 percent return on a 10-year CD, would you jump at the 4 percent, right? Why would anyone tie their money at a lower rate?
We tell you why: If you think the economy is about to refuel and interest rates are slowing down. For example, if you were worried that CD prices were about to go back to 1 percent, as they were during the big recession, you would be smart to lock in the 3 percent long interest rate. Very smart. Believe, do you not want you to go back in time and buy 30-year US government bonds of 6 percent or 7 percent, roughly the current rate of mid-1990s?
That is why observers are concerned that the yield curve inverted early in 2019. Specifically, three-month treasury payments in March paid higher returns than 10-year Treasurys. When investors start pouring money into the long-term government bonds – which are bought and sold in the aftermarket, they are similar to how the stock trading is – which suggests they are worried about the economy, and that drives prices down.
A similar inversion happened more recently on May 13, 2019:
Source: State Finance Ministry
If you were to buy a long-term American bond, you would I expect to earn higher interest rates than a short-term bond. And if you thought about buying a medium-term bond, you could expect to earn a short-to-long-term rate. Let's go back to CD: Remember an average 1-year CD pays 0.88 percent, a 2-year CD pays a little better, with 0.99 percent, which you can expect when a 5-year CD yields 1.44 percent. It is typical how it goes with CDs and government bonds.
If you were to plot the short, medium and long-term interest rates that I just described on a chart, you would get a curved line. That is what Wall Streeters (and economists) refer to as the yield curve.
And in normal times, the shape of this curve is probably exactly what you imagine – something of the high school class that is steadily rising from low levels in short term to higher and higher prices in the longer term.
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What does an inverted yield curve for the economy mean?
An inverted yield curve is not only very unusual, but it is an extremely economic indicator. An inversion between the 3-month and 10-year bonds has preceded every recession on record since 1960, according to the Federal Reserve. In fact, research quoted by the Federal Reserve suggests the relationship between an inverted yield curve and an uneven economic point of view as far back as 1858.
An inverted yield curve is an indicator that a recession may come … "may be" the decisive factor. word. The economy is always changing, and there are other potential explanations for this unusual condition.
An economic card published by the Federal Reserve Bank of Richmond offers hope that this time, things can be different. Perhaps low interest rates are guilty or at least they make inversions less likely preachers to trouble, the paper speculates. The interest rates have been very low for a long time, so there is not much difference in any case short and long-term Treasurys. So there is no upward slope for long-term investors. Economists say the yield curve has "flattened". The Fed paper notes that the term premium has been 1.6 percent since 1961, but it had fallen all the way to 0.20 percent by 2012. In this new, nicer world, perhaps a temporary dip of 10-year state tax under 3- months of treasury are more likely.
"If the futures premium narrows, the curvature inversions will be more likely even if there is no increased risk of recession," said Fed paper. "If the term premium continues in that interval in the foreseeable future, the exchange curves will be much more likely in the future, everything else (such as the state of the economy) is the same."
In other words, don & # 39; Don't overreact to news about the yield curve. Past performance is no guarantee of future returns. Yet it is a data point and an important one. As always, it is best to keep up with your investments, do your research, talk to professionals, make a wise plan based on good principles, and stick to it.
Bob Sullivan is a veteran journalist and author of five books, including the bestseller in the New York Times 2008, "Gotcha Capitalism", and Best Sellers for the New York Times 2010, "Stop Ripping!" He specializes in computer crime and consumer fraud. He has won the Society of Professional Journalists' Public Service Award, a Peabody Award, and the Consumer Federation of America's Betty Furness Consumer Media Service Award. He is now a syndicated columnist and frequent TV guest. He also hosts the podcast crime, which examines history's greatest hacking stories. Opinions are his own.
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