With all the talk and anger about the yield curve and what it could mean, it’s important to take a step back to analyze what a yield curve is, what it’s meant to share with investors, and how it’s headed in the future. of the economy can lead.
Basic fixed income formula (inverted):
Interest Rates + Prices – Returns +
First, the US Treasury yield curve shows yields from short-term Treasury bills compared to yields from long-term Treasuries (2-10 years maturities) and bonds (maturities longer than 10 years). It shows the relationship between the interest rates and the maturities of US Treasuries that range from 1, 2, 3 and 6 months and 1, 2, 3, 5, 7, 10, 20 and 30 years.
Second, the yield curve can behave in three different ways: flat, inverted or steep.
There is a flat yield curve when the yields are comparable over all maturities. Some intermediate maturities may have slightly higher yields, causing a slight bump in the early to mid-term of the curve, and are usually for the medium-term maturities, six months to two years. Such a flat or rising yield curve implies an uncertain economic situation. It may come at the end of a period of high economic growth leading to inflation and fear of slowing down. It may appear at times when the central bank is expected to raise interest rates.
An inverted yield curve is when yields slope downward and means that short-term interest rates are higher than long-term ones. Such a yield curve corresponds to periods of economic recession in which investors expect yields on longer-term bonds to fall even lower in the future. In addition, in an economic downturn, investors seeking safe investments tend to buy these longer-dated bonds rather than short-dated bonds, raising the price of longer bonds, decreasing their yields.
With a normal or steep yield curve, yields on longer-term bonds may continue to rise in response to periods of economic expansion. This type of yield curve states that longer-term bonds have a higher yield to maturity than shorter-term bonds.
Third, based on how short and long-term interest rates move, there are two main ways to classify the moves:
A flattener is when traders and/or investors would like to sell the spread, meaning they would make the front of the yield curve short and the back long. This happens from one of two scenarios:
A bull flattener is when longer-term interest rates fall faster than shorter-term interest rates. This usually happens when the change in the yield curve often precedes the Fed cutting short-term interest rates, which is bullish for both the economy and the stock market.
A bear flattener is when short-term interest rates rise faster than long-term. This usually happens when the change in the yield curve often precedes the Fed raising short-term interest rates, which is bearish for both the economy and the stock market.
A steeper is when traders and/or investors would like to buy the spread, which would mean buying the front of the yield curve and shorting the back. This again happens from one of two scenarios:
A bull steeper is when short-term interest rates fall faster than long-term interest rates. This often happens when the Fed is expected to cut interest rates, which is a positive sign for both the economy and stocks.
A bear steeper is when the long-term interest rate rises faster than the short-term interest rate. This often happens when inflation expectations rise, after which the market can anticipate a Fed raising to combat emerging inflation, which would be bearish for both the economy and the stock market.
Given the current environment, we find ourselves with an inverted yield curve at various maturities across the interest rate spectrum. The five-year yield reversed again last week and today against the thirty-year yield. Late last week, the two-year yield had reversed above its longer-term counterparts. This clearly shows an inverted yield curve and a bear flattener scenario, as short-term rates are rising faster than long-term rates, historically indicating that investors are bracing for rotation towards safer assets and assets that can withstand an economic downturn.
Investors and traders alike can also use ETFs to track government bond yields at different maturities:
$FVX – 5 Year Treasury Yields;
$TNX – 10-Year Treasury Yields;
$TYX – 30 years of Treasury returns;
Other Treasury ETFs:
$TIP – TIPS Bond ETF;
$SHY – 1-2 Year Government Bonds;
$IEI – 3-7 Year Treasury Bonds;
$IEF – 7-10 Year Treasury Bonds;
$TLT – 20-Year Treasury Bond;
This article was submitted by a third-party contributor and may not reflect the views and opinions of Benzinga.
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This post What does the yield curve say? was original published at “https://www.benzinga.com/economics/22/04/26513291/what-is-the-yield-curve-saying”