If we compare 10-year and 30-year bonds, nobody doubts that unfavorable things can happen in a 30-year period with a higher statistical probability than in a 10-year period. For this reason, typically the yield on a 30-year bond is greater than the yield on a 10-year bond.
An ascending or positive curve occurs at times of expansion of the economy, with GDP growing 2-3 quarters in a row, creating jobs and increasing consumer confidence.
That is why the logical thing is that the interest rate curve has an upward slope, the following graph being an example:
When it is said that the yield curve is inverted, it refers to the fact that the yield of short-term bonds is higher than that of bonds that have a longer term. In these cases, the representation of the inverted curve would be like the one in the following graph:
Why does the yield curve invert?
The reason why the yield curve inversion occurs is simply due to a lack of confidence in the future of the economy, to the fact that uncertainty appears, fears, not knowing what is going to happen or fearing the worse (the possible arrival of an economic crisis, a recession, etc).
Why is an inverted yield curve so important?
The appearance of an inverted interest rate curve is a fairly serious and reliable sign that an economic recession is approaching for the country in question.
An inverted yield curve presents both good news and bad news:
- The good news is just that it is a pretty solid tool as a warning or signal that a recession in the economy is coming.
- The bad news is the time that elapses between the inversion of the curve and the arrival of the recession, since we are talking about one or two years.
The most followed yield curve in the world is that of the United States and can be seen on the Stockcharts website. In the case of wanting to follow the curve of Europe, it can be done on the website of the Central European Bacchus.
Which yield curves are the most important?
Among the different yield curves, we can highlight two as important and relevant:
- The curve that is established between the 3-month bonds and the 10-year bonds: the average time span from the inversion of the yield curve until the arrival of the recession was one year and seven months.
- The curve of the 2-year bonds and the 10-year bonds: this spread is surely the best to follow, in fact it is usually the most followed by investors. Suffice it to say that if we take the last five recessions, it was very useful because it always warned of the arrival of the recession.
If you would like to know more about an inverted yield curve, you can visit Exfor website. For the first time ever, we offer traders direct prices from a liquidity provider. Don’t miss your chance to subscribe for just $300 per year and ensure your trading success!
