How The Yield Curve and The Future Are Related
While there is no definite method for predicting the economic future, the yield curve does provide us with fact-based signs that can serve as a guide when making investment choices. And here are some questions and answers that will help you in applying a study of the yield curve to your own investment strategy.
What is the yield curve?
The yield curve is a graphical representation of the interest rate movements of U.S. Treasury bonds of various maturities. While the rates of bonds of different maturities move independently - even in opposite directions - the curve itself depicts an overall pattern of rate movement in a single graphic, and the type of curve can be an indicator of either a future expansion of, or recession in, the U.S. economy.
What types of curves are there?
There are typically three types of curves:
1. A "normal" curve - which occurs when long-term rates are higher than short-term rates. This generally indicates that the Fed will be friendly toward the markets, with a steeper curve indicating economic expansion.
2. A "flat" curve - which occurs when all maturities have the same yields. This can be a predictor of an economic transition, signaling a move either into or out of a recession.
3. An "inverted" curve - which occurs when short-term rates move higher than long-term rates. This often means the Fed is intentionally slowing the economy, and that investors feel that interest rates will eventually move lower. A steeper inversion often accurately indicates a greater risk of recession. In fact, eight of the nine most recent bear markets occurred along with or shortly after a yield-curve inversion.
How can you use the yield curve?
If you invest in bonds, the yield curve can help you determine which maturities may be right for you. If you hold credit card debt or an adjustable-rate mortgage, the curve can help you determine if you should consider changes in how you manage that debt. And because of its depiction of the potential expansion or recession of the U.S. economy and financial markets, the yield curve can also help you decide how much to weight your portfolio toward U.S. equities.
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What is the yield curve?
The yield curve is a graphical representation of the interest rate movements of U.S. Treasury bonds of various maturities. While the rates of bonds of different maturities move independently - even in opposite directions - the curve itself depicts an overall pattern of rate movement in a single graphic, and the type of curve can be an indicator of either a future expansion of, or recession in, the U.S. economy.
What types of curves are there?
There are typically three types of curves:
1. A "normal" curve - which occurs when long-term rates are higher than short-term rates. This generally indicates that the Fed will be friendly toward the markets, with a steeper curve indicating economic expansion.
2. A "flat" curve - which occurs when all maturities have the same yields. This can be a predictor of an economic transition, signaling a move either into or out of a recession.
3. An "inverted" curve - which occurs when short-term rates move higher than long-term rates. This often means the Fed is intentionally slowing the economy, and that investors feel that interest rates will eventually move lower. A steeper inversion often accurately indicates a greater risk of recession. In fact, eight of the nine most recent bear markets occurred along with or shortly after a yield-curve inversion.
How can you use the yield curve?
If you invest in bonds, the yield curve can help you determine which maturities may be right for you. If you hold credit card debt or an adjustable-rate mortgage, the curve can help you determine if you should consider changes in how you manage that debt. And because of its depiction of the potential expansion or recession of the U.S. economy and financial markets, the yield curve can also help you decide how much to weight your portfolio toward U.S. equities.
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posted by Bob Moser at
3:07 PM
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