The yield curve shows rates of borrowing in relation to periods of time. It specifically shows differences in the short term and long term yields. There are multiple yield curves, but government bonds are the most closely tracked, since they set interest rate trends. They are the basis of “risk free” investment rates for a local market.
The Yield Curve itself has a vertical yield axis, a horizontal time axis, and a curve displaying yields as they relate to time. Rates generally increase over the length of the term. The steepness of the curve indicates the increase in yield a bondholder can receive buying longer terms. This increase is often necessary. You need a reward to offset the greater risks you will encounter from loaning money long term. A lot of problems can occur over the course of 10 to 30 years. Central banks can raise rates, bond values can decrease, firms can default, and economies can crash. A higher yield for a long term bond reflects these possibilities, and compensates you for taking them.
This may lead you to believe a yield curve will always increase in steepness. It does not. Sometimes, the yield curve will be flat. There will be no additional reward for long term bonds compared to short term bonds in the category. Even more strangely, in rare situations short term bonds actually return higher yields than long term bonds. This is known as an Inverted Yield Curve.
You’d be inclined to believe that there’s no benefit possible to investing in midterm or long term bonds if the yield curve is flat or inverted. That’s incorrect. When a financial crisis or uncertainty occurs, the market seeks shelter in bonds or commodities (such as oil, gold, and diamonds). The demand raises the price of these asset categories. Central banks usually lower interest rates to accelerate economic growth which increases the market price of existing bonds above the new rates.
Long term bonds and midterm bonds may see larger increases in market price than short term bonds due to their higher price volatility. The benefit to having purchase those bonds after a lowering of interest rates will be the profit from sales after the value of those long term bonds increases. Additionally, if rates have dropped you will be forced to buy lower yields as your existing short term bonds come due. If you didn’t buy long term bonds you would be forced to reinvest your short term bond maturities into lower interest rates. Your orientation towards purchasing long term bonds with flat or inverted yield curves should be approached based on the market situation.
Note that in most cases, the 5 year yield is below the 10 year yield, which is below the 20 year yield. When inverted, the 5 and the 10 year yield are both higher than the 20 year yield. Flattening occurs when all the yields begin to merge together, and inversion occurs when the 5 year rises above the 10, which rises above the 20.
Did we help you? Vote with a Crypto-Donation!
Donate Bitcoin Cash
International Economic Analysis:
- Major Currency Economic Summaries
- Performance of Major Imports and Exports
- Mandates of Central Banks versus Expectations
- Performance Indexes of Major Economies
- Economically Correlated Currency Projections
- Large Funds Currency Sentiment Readings
- List of Technical Indicators to Look For
- Occasional: Foregin Exchange Technicals Markups
American Markets Analysis:
- Summaries of American Economic Structure
- Performance of Major
- Federal Reserve Mandate versus Expectations
- Performance Indexes of U.S Economy
- Economically Correlated U.S Dollar Projections
- Large Trading Fund Index Sentiment Readings
- Market Wide Earnings Versus Valuations
- Fundamental Ranking of U.S Business Sectors
- Best and Worst Future Consensus Estimates
- Occasional: Firm Fundamental Strength Report
- List of Technicals to Look for While Trading
Investment and Finance, Serviced by Amazon
No Results Found
The page you requested could not be found. Try refining your search, or use the navigation above to locate the post.