{"id":147425,"date":"2019-05-10T11:15:18","date_gmt":"2019-05-10T15:15:18","guid":{"rendered":"https:\/\/www.countingpips.com\/?p=147425"},"modified":"2019-05-10T09:57:02","modified_gmt":"2019-05-10T13:57:02","slug":"why-you-should-care-about-yield-curve-inversion","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2019\/05\/why-you-should-care-about-yield-curve-inversion\/","title":{"rendered":"Why You Should Care About Yield Curve Inversion"},"content":{"rendered":"
May 10, 2019<\/div>
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By <\/strong>Orbex<\/strong><\/a><\/p>\n

The importance of an inversion in the bond yield curve is in its reputation.<\/p>\n

Of the last nine recessions, it correctly predicted\u00a0nine of them (or ten, if you count the economic slowdown in the mid-\u201960s). There isn\u2019t any other economic indicator that has that success ratio.<\/p>\n

So, when people talk about curve inversion, investors usually pay attention.<\/p>\n

By being able to predict when there will be a recession, it by default predicts when there\u00a0won\u2019t\u00a0<\/em>be a recession. If the yield is not inverted, then presumably the risk of a recession in the near term is low.<\/p>\n

Now, of course, this applies to the US economy. This is because the bond yields we talk about\u00a0are specifically those\u00a0in the US. However, since the US is still the world\u2019s largest economy, what happens there will have knock-on effects around the world.<\/p>

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The Yield Curve<\/strong><\/h2>\n

The US government issues bonds that have different maturities. Those that mature in less than a year are called bills, whereas those that mature between 1 and 10 years are called notes. The ones that mature even longer than that are just bonds.<\/p>\n

The government is able to issue any kind of maturity. However, usually, they repeat the same pattern: 30 days, 90 days, 1 year, and all the way up to 30-year bonds. The yields on those bonds vary depending on different economic factors at the time.<\/p>\n

If you plot the yields of all these bonds in a graph, you get what mathematicians call a \u201ccurve\u201d, but most of us call a line. Often it\u2019s curved, but not always and not necessarily.<\/p>\n

Under normal circumstances, the yield should be higher the longer the bond maturity. This is because the farther in the future you have to wait to get paid back, the more uncertainty there is. Treasury bills (the shortest) will, all things being equal, have a lower yield than notes. And these will have a lower yield than bonds maturing past 10 years.<\/p>\n

Here\u2019s what that graph looked like at the beginning of the year (the bottom shows the maturity and the y-axis has the yield):<\/p>\n

\"forex<\/a><\/p>\n

The Inversion<\/strong><\/h2>\n

An inversion happens when the normal situation (that is, an ascending curve) inverts, and shorter-term bonds (bills) have a higher yield than\u00a0long term bonds<\/a>\u00a0(notes). The angle of the slope isn\u2019t as important as the inversion of the logic behind each bond\u2019s yields. When shorter-term bonds have higher yields, it means investors expect rates to be lower in the future.<\/p>\n

This happens because as the Fed raises rates during a growing economy, it pushes the whole yield curve higher. But,\u00a0bond<\/em>\u00a0yields in the near future might go down. Why? Because when there is a recession, the Fed cuts rates in a desperate attempt to get the economy going.<\/p>\n

Thus, if investors expect a recession, the yield for notes drops in anticipation of lower interest rates during and following the recession.<\/p>\n

It\u2019s not unusual for some of the curves to invert depending on the ebb and flow of demand. But, the classic definition of an inversion is when the yield on bills exceeds the yield on notes.<\/p>\n

Why You Shouldn\u2019t Care About an Inverted Yield Curve<\/strong><\/h2>\n

Nothing is perfect, and just because something worked in the past, it doesn\u2019t mean it will in the future. The predictability of the yield curve was determined in the late \u201990s and got wide-spread notice after the \u201908 recession.<\/p>\n

Now that everyone is aware of it, the market might behave differently, as investors try to \u201cget ahead\u201d of the market. Additionally, the Fed expanded its balance sheet significantly during the last credit crunch, which was an unprecedented move. It now is in the process of selling off extra treasuries, which\u00a0might cause distortions in the yield curve<\/a>.<\/p>\n

By <\/strong>Orbex<\/strong><\/a><\/p>\n

 <\/p>\n","protected":false},"excerpt":{"rendered":"

By Orbex The importance of an inversion in the bond yield curve is in its reputation. Of the last nine recessions, it correctly predicted\u00a0nine of them (or ten, if you count the economic slowdown in the mid-\u201960s). There isn\u2019t any other economic indicator that has that success ratio. So, when people talk about curve inversion, […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-147425","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/147425","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=147425"}],"version-history":[{"count":2,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/147425\/revisions"}],"predecessor-version":[{"id":147436,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/147425\/revisions\/147436"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=147425"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=147425"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=147425"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}