The Clap
The U.S. yield curve is flattening & could be on its way for its first inversion in 16 years. Investors are worried.
The deets
Investors often look at the bond market for clues on how the economy will perform, specifically the yield curve.
What’s the yield curve?
It’s a graph showing the relationship between short-term & long-term interest rates of U.S. government-issued bonds. Usually, short-term rates are lower than long-term rates because investors expect higher returns over longer periods. If short-term rates start rising above long-term rates, the yield curve starts flattening, & could even “invert”.
What causes the yield curve to invert?
There are two drivers that could lead to the inversion of the yield curve. First is the Fed raising short-term interest rates, which it recently did. The second driver is investor sentiment. When investors believe the economy is headed towards a rough patch, they start pouring money into safe long-term bonds, causing their prices to go higher.
Bond prices have an inverse relationship with bond yield. Therefore, with short-term yields rising & long-term yields falling, an inverted yield curve happens once the short-term yield overtakes the long-term yield.
Why this matters
Investors see inverted yield curves as a warning that a recession is on its way. In fact, for the past 50 years every time, the yield curve inverted a recession followed. It wasn’t until the 1980s that policymakers started to catch on.
