This is a Guest Post by AK of Fallible
AK has been an analyst at long/short equity investment firms, global macro funds, and corporate economics departments. He co-founded Macro Ops and is the host of Fallible.
Today we’re going to talk about the yield curve. Recently the financial media has been raving about the yield curve getting closer and closer to inverting and how it’s a signal that a recession is right around the corner. In this video we’re going to go over what the yield curve is, how to use it, and what it’s really signaling about the market.
The yield curve is basically just a line that plots the yield of US treasury bonds (TLT) with different maturity dates. The curve lets you easily compare rates on short term bonds versus long term bonds. When long term bonds are yielding more than short term bonds, the line rises from left to right. And when this is the case, it’s called a normal yield curve. This is a signal that the economy and market are doing okay.
When you start to see the yield curve flatten or even invert, meaning short-term rates become equal to or higher than long-term rates, and the line either becomes flat or sloped lower from left to right, then that usually signals trouble ahead in terms of a recession and lower market prices.
Two things happen for the yield curve to become like this. First, the Fed starts raising short-term rates. Based on their mandates, they may see the economy overheating and decide to raise rates to slow it down. Higher rates hurt economic expansions.
Second, investor expectations for the future become negative. And because of that, they buy up long-term bonds, lowering their yield. Those two together you a flat or inverted yield curve where short term bonds yield the same or even more than long-term bonds. And like this signals trouble ahead.
To learn more, make sure you watch the video above!
And as always, stay Fallible out there investors!
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***All content, opinions, and commentary by Fallible is intended for general information and educational purposes only, NOT INVESTMENT ADVICE.