And what is the “Yield Curve” anyway?
The yield curve is usually considered the difference in bond yields between bonds of different maturities. The common use is comparing short term debt yield with longer term debt yield.
Commonly, longer term debt has higher interest than shorter term debt. This is because locking your money in longer term bonds is considered more at risk than monies one will receive sooner.
This concept, that longer term debt is generally at higher risk is sometimes referred to as the “risk premium.”
Upside Down
When shorter term debt has a higher interest rate than longer term debt, the yield curve is called “inverted.” When there is a pronounced inverted yield curve, many feel this is a prelude to a recession. Historically this has been true. As a result, analysts seemingly “predict” a recession.
The yield curve is considered “flat” when short term and long term debt have the same yield. This condition is said to indicate an uncertain economic situation.
Those that follow and analyze interest rates and the bond market carefully watch the yield curve. History provides guidance of the past, but does not predict the future. Many things could be possibly inferred from yield curve data.
Now and Not Later
When the Federal Reserve increases interest rates, the interest on shorter term bonds can be higher than longer term bonds. This situation is not necessarily indicate an imminent recession.
Who
The most widely watched comparison is the U.S. Treasury yields, although other bonds are also analyzed, such as UK bonds, LIBOR rates, and corporate bonds, for examples.
Individual Investor
Whether yield curve predictions are relevant to the individual investor is an open question. Personally, I watch what is happening and invest accordingly. Predictions do not excite me. If interest rates climb, I may invest in a few CDs. Otherwise, equities with dividends are the name of the game for me.
Where to Start Learning
Much has been written about the yield curve, and it seems much more will. Here are a few resources where to begin studying the yield curve.
Wikipedia, as always, provides a comprehensive overview at “Yield curve”
Investopedia has a good summary with examples at “Yield Curve: What It Is and How to Use It”
Those so inclined can view data directly at the U.S. Treasury’s website: “Daily Treasury PAR Yield Curve Rates”
The website US Treasury Yield Curve plots Treasury data.
Thanks to reader Daniel B. for suggesting this topic.
Does the yield curve affect your investing? Let me know here.
“The Spaniard” is one of numerous prints from the 1562 book “Recueil de la diversité des habits” (A Collection of the Various Styles of Clothing) by François Desprez. It is considered the first “costume book” ever published. Courtesy Rijksmuseum, Amsterdam, Netherlands.
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