Conceptually: *Why* does the Yield Curve invert?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
BuyAndHoldOn
Posts: 199
Joined: Mon Mar 30, 2015 6:51 pm

Conceptually: *Why* does the Yield Curve invert?

Post by BuyAndHoldOn » Thu Dec 28, 2017 2:43 pm

Hello,

My questions are: Why does the yield curve invert? If short term rates are higher than long-term rates, wouldn't you want to "lock in" the HIGHER rates that are available with less duration?

* Is this a play for Capital Gains, due to the price changes of longer duration bonds when interest rates drop?
* On a related note: Is the concern [of an investor] that the shorter-duration bonds, when they mature, can only [theoretically] be invested in lower-yielding instruments; and thus, a longer-duration bond locks in a higher yield for a longer period of time?


Context is:
I [claim to] know the basics of yield curve inversion. Below is a pretty succinct summary.
http://gregmankiw.blogspot.com/2006/06/ ... -mean.html
Q: Why would the yield curve ever invert?

A: The yield curve inverts when bond investors expect short-term interest rates to fall. They are willing to hold long-term bonds, despite the lower current yield, because they are locking in the yield.


What I do not understand is: Basically what I asked above. Why not take the higher rates that are available on the shorter-term part of the yield curve?

Thanks in advance!

texas lawdog
Posts: 92
Joined: Tue Jun 07, 2016 5:33 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by texas lawdog » Thu Dec 28, 2017 3:36 pm

Some will argue that inverted yields is a leading indicator of a recession. Investors that have little faith in short term economic conditions will actually give up yield to keep their money safe for a longer period of time. As more investors demand long-term notes, those notes can be at a lower yield than the short-term notes (and become inverted).

Typically, it would make more sense to take the shorter duration with a higher yield, but during a recession the investor would buy a longer term note with safety being a higher priority than yield.

jdilla1107
Posts: 603
Joined: Sun Jun 24, 2012 8:31 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by jdilla1107 » Thu Dec 28, 2017 3:47 pm

BuyAndHoldOn wrote:
Thu Dec 28, 2017 2:43 pm

What I do not understand is: Basically what I asked above. Why not take the higher rates that are available on the shorter-term part of the yield curve?
Which would you rather do:

-Earn 3% interest for 1 year and then 1% interest for another 9 years
- Earn 2% interest for 10 years

This is an example of a possible outcome with a 10 year bond @ 2%, while a 1 year bond is @ 3%.

The key to understanding this is that when the 1 year bond expires, you have to put the money somewhere. You will be "forced" into investing at a possible lower yield after 1 year. (This assumes that short term rates actually fall)

UniversityEmployee9
Posts: 104
Joined: Wed Mar 18, 2015 10:01 am

Re: Conceptually: *Why* does the Yield Curve invert?

Post by UniversityEmployee9 » Thu Dec 28, 2017 3:56 pm

texas lawdog wrote:
Thu Dec 28, 2017 3:36 pm
Some will argue that inverted yields is a leading indicator of a recession. Investors that have little faith in short term economic conditions will actually give up yield to keep their money safe for a longer period of time. As more investors demand long-term notes, those notes can be at a lower yield than the short-term notes (and become inverted).

Typically, it would make more sense to take the shorter duration with a higher yield, but during a recession the investor would buy a longer term note with safety being a higher priority than yield.
You've got this backwards. Long term debt typically has higher yields commensurate with higher risk and short term debt has lower yields because it carries less risk. The worry when long term yields start to match short term yields is that the market is overbought and investors are trying to squeeze yield out of rocks.

lack_ey
Posts: 6635
Joined: Wed Nov 19, 2014 11:55 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by lack_ey » Thu Dec 28, 2017 4:10 pm

There are various ways to interpret and decompose the yield curve, but all the above responses including the original post are missing a key component: the term risk premium (or something else similar encompassing risk and other factors beyond expectations of future rates).

If all investors were risk agnostic and there were no preferences on maturity, you would expect a similar return over a certain period whether you're investing in the short, intermediate, or long rates. If short-term rates are less than long-term rates, that means everybody expects on average for short-term rates to increase, equalizing the returns. If short is greater than long, then everybody expects a decrease, likewise evening out returns. Rates across this yield curve reflect expectations of future rates. These represent the risk-neutral rates.

The real world deviates from risk-neutral rates based on additional considerations relating to inflation expectations (that is, including risk of unexpected inflation), uncertainty about future rates and the pricing of that unknown component, liquidity, investor demand at certain maturities relative to outstanding issuance, perceptions of safety and relationships with other assets, etc. These considerations and their pricing are the reason why the expectations hypothesis for interest rates has empirically been very wrong.

An inverted yield curve could thus also arise from a negative term premium, excess demand for longer bonds relative to the short end, even if shorter rates are not expected to decrease in the average future scenario. More likely it comes from expectations that future rates will fall, or some combination of factors, but my point is that's it's not necessarily just about expectations about future rates.

Now, the issue is that these components are not explicitly observable. Some estimates do have a negative term premium [edit: I mean, right now, talking about today's yield curve], though, meaning that it expects higher returns on average from short rates (even though the short rates are lower and the yield curve is upwards sloping, it's perhaps not enough to make up for increasing short rates, so for example investing in cash/T-bills for 5 years may have higher returns than holding a 5-year Treasury for 5 years, even though the 5-year is currently yielding more).
Last edited by lack_ey on Thu Jan 04, 2018 10:09 pm, edited 3 times in total.

User avatar
patrick013
Posts: 2430
Joined: Mon Jul 13, 2015 7:49 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by patrick013 » Thu Dec 28, 2017 4:31 pm

BuyAndHoldOn wrote:
Thu Dec 28, 2017 2:43 pm

A: The yield curve inverts when bond investors expect short-term interest rates to fall. They are willing to hold long-term bonds, despite the lower current yield, because they are locking in the yield.[/i]
That's the value of perfect information. Are they certain. No guessing allowed.

So the intermediate and/or long term return will be greater than the sum of
short term returns expected.
age in bonds, buy-and-hold, 10 year business cycle

grok87
Posts: 8509
Joined: Tue Feb 27, 2007 9:00 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by grok87 » Thu Dec 28, 2017 5:22 pm

default risk?

https://events.barcelonagse.eu/live/fil ... ancierepdf
wrote: We present novel evidence that, in present value terms, creditors with short maturity
securities suffer significantly more than creditors with long maturity securities during
recent sovereign debt restructuring episodes. We also document a new stylized fact,
consistent with this novel evidence, that the sovereign yield curve becomes systematically
inverted as countries are approaching sovereign default or restructuring. We then show,
using a simple model of sovereign debt, how model-implied differential NPV haircuts
between short- and long-term creditors, can explain the observed dynamics of the sovereign
yield curve.
Keep calm and Boglehead on. KCBO.

lack_ey
Posts: 6635
Joined: Wed Nov 19, 2014 11:55 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by lack_ey » Thu Dec 28, 2017 5:25 pm

grok87 wrote:
Thu Dec 28, 2017 5:22 pm
default risk?

https://events.barcelonagse.eu/live/fil ... ancierepdf
No. At least not really for the US yield curve or other developed markets with low market-perceived risk of default. Check CDS rates and flows, investor sentiment and opinions, etc. during these times.

But more generally, sure, that can be another reason.

User avatar
triceratop
Moderator
Posts: 5756
Joined: Tue Aug 04, 2015 8:20 pm
Location: la la land

Re: Conceptually: *Why* does the Yield Curve invert?

Post by triceratop » Thu Dec 28, 2017 5:28 pm

grok87 wrote:
Thu Dec 28, 2017 5:22 pm
default risk?

https://events.barcelonagse.eu/live/fil ... ancierepdf
wrote: We present novel evidence that, in present value terms, creditors with short maturity
securities suffer significantly more than creditors with long maturity securities during
recent sovereign debt restructuring episodes. We also document a new stylized fact,
consistent with this novel evidence, that the sovereign yield curve becomes systematically
inverted as countries are approaching sovereign default or restructuring. We then show,
using a simple model of sovereign debt, how model-implied differential NPV haircuts
between short- and long-term creditors, can explain the observed dynamics of the sovereign
yield curve.
To be clear you're saying that the market is concerned about US default risk every time the yield curve inverts? I would suggest that observing A => B doesn't imply B always being caused by A.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

UpperNwGuy
Posts: 1244
Joined: Sun Oct 08, 2017 7:16 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by UpperNwGuy » Thu Dec 28, 2017 5:54 pm

I ignore this phenomenon and "stay the course."

User avatar
BlueEars
Posts: 3634
Joined: Sat Mar 10, 2007 12:15 am
Location: West Coast

Re: Conceptually: *Why* does the Yield Curve invert?

Post by BlueEars » Thu Dec 28, 2017 6:47 pm

BuyAndHoldOn wrote:
Thu Dec 28, 2017 2:43 pm

My questions are: Why does the yield curve invert? If short term rates are higher than long-term rates, wouldn't you want to "lock in" the HIGHER rates that are available with less duration?

* Is this a play for Capital Gains, due to the price changes of longer duration bonds when interest rates drop?
* On a related note: Is the concern [of an investor] that the shorter-duration bonds, when they mature, can only [theoretically] be invested in lower-yielding instruments; and thus, a longer-duration bond locks in a higher yield for a longer period of time?
...
My guess is that the Fed always tries to engineer a "soft landing". It drives up the short rates. The yield curve inverts partly because investors like myself are balancing a stock portfolio with intermediate term bonds. That balance is a hedge against a possible recession which is pretty well correlated with an inverted yield curve. The intermediate bonds generally do better then short Treasuries when recessions show up. This graph shows 3 recessions preceded by yield curve inversion. Note this is clearly not the only variable but is it coincidence that recessions followed some months later? Yield curve inversion preceded the 1930 depression.

Image
.
Last edited by BlueEars on Thu Dec 28, 2017 7:54 pm, edited 1 time in total.

Buddtholomew
Posts: 980
Joined: Thu Mar 01, 2007 3:29 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by Buddtholomew » Thu Dec 28, 2017 7:52 pm

Doesn’t the curve invert when cost to borrow in the short term is more expensive than in the long-term. In other words, the money supply is tight and borrowing in the near term (short duration bonds) comes with a higher interest rate.
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.

User avatar
BuyAndHoldOn
Posts: 199
Joined: Mon Mar 30, 2015 6:51 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by BuyAndHoldOn » Thu Dec 28, 2017 8:21 pm

Thank you for the responses, all. The different answers/perspectives are helpful.

lack_ey: Special thanks for bringing up the term premium.

User avatar
patrick013
Posts: 2430
Joined: Mon Jul 13, 2015 7:49 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by patrick013 » Thu Dec 28, 2017 8:30 pm

BlueEars wrote:
Thu Dec 28, 2017 6:47 pm
This graph shows 3 recessions preceded by yield curve inversion. Note this is clearly not the only variable but is it coincidence that recessions followed some months later? Yield curve inversion preceded the 1930 depression.

Image
.
Lower grade bonds are also affected. Their yields are below their related metric,
in this case the Prime compared to 20+ year low investment grade corp bonds.
The observation occurs about 10% of the time when the Fed spikes the FFR to
head off inflation and slowing runaway growth. The other 90% of the time more
logical term spreads should be observed according to liquidity preference. The
FFR presently is not spiking but rising gradually but could start the same effect.
Have to wait and see. :)

Image
age in bonds, buy-and-hold, 10 year business cycle

jalbert
Posts: 3935
Joined: Fri Apr 10, 2015 12:29 am

Re: Conceptually: *Why* does the Yield Curve invert?

Post by jalbert » Thu Dec 28, 2017 8:47 pm

When the Fed embarks on a rate raising campaign, it is not aberrational for the yield curve to flatten. The Fed raising rates exerts substantial upward pressure on short rates (note the 100-120 bp rise in Vanguard MMF yields). Rising short rates taps the brakes on the economy, which exerts downward pressure on the trajectory of future inflation rates, exerting downward pressure on medium and long rates. Of course the Fed is raising rates because the economy is believed to be healthy and growing, which can increase inflation. So there is a tug of war between these two opposing forces on inflation, and future medium and long rates have a fair correlation to future inflation.

When Alan Greenspan started raising rates after recovery from the dotcom meltdown and 9/11, I think in June 2004, the yield curve also flattened during the process.

{Edited to correct a typo and add this note.}
Last edited by jalbert on Thu Dec 28, 2017 10:18 pm, edited 13 times in total.
Risk is not a guarantor of return.

grok87
Posts: 8509
Joined: Tue Feb 27, 2007 9:00 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by grok87 » Thu Dec 28, 2017 9:41 pm

triceratop wrote:
Thu Dec 28, 2017 5:28 pm
grok87 wrote:
Thu Dec 28, 2017 5:22 pm
default risk?

https://events.barcelonagse.eu/live/fil ... ancierepdf
wrote: We present novel evidence that, in present value terms, creditors with short maturity
securities suffer significantly more than creditors with long maturity securities during
recent sovereign debt restructuring episodes. We also document a new stylized fact,
consistent with this novel evidence, that the sovereign yield curve becomes systematically
inverted as countries are approaching sovereign default or restructuring. We then show,
using a simple model of sovereign debt, how model-implied differential NPV haircuts
between short- and long-term creditors, can explain the observed dynamics of the sovereign
yield curve.
To be clear you're saying that the market is concerned about US default risk every time the yield curve inverts? I would suggest that observing A => B doesn't imply B always being caused by A.
well i did put a "?" after my "default risk" comment.
:)
agree with lackey that default risk is perhaps less applicable to US and other major developed economies.

here's a good recent deck on the issue of yield curve inversion in the US

https://www.stlouisfed.org/~/media/File ... .pdf?la=en
"Assessing the Risk of Yield Curve Inversion"

he projects that yield curve may invert late next year, if...

the fed keeps raising the fed funds rate
long term (e.g. 10 year) treasury rate does not rise from current levels due to flattish economic growth and/or tame inflation expectations
Keep calm and Boglehead on. KCBO.

grok87
Posts: 8509
Joined: Tue Feb 27, 2007 9:00 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by grok87 » Thu Dec 28, 2017 9:54 pm

lack_ey wrote:
Thu Dec 28, 2017 5:25 pm
grok87 wrote:
Thu Dec 28, 2017 5:22 pm
default risk?

https://events.barcelonagse.eu/live/fil ... ancierepdf
No. At least not really for the US yield curve or other developed markets with low market-perceived risk of default. Check CDS rates and flows, investor sentiment and opinions, etc. during these times.

But more generally, sure, that can be another reason.
agree but even for non-developed markets there is arguably no risk of default for local currency denominated bonds. they can always just print more local currency right?- of course that usually leads to higher inflation...that's another way of saying that default risk and inflation risk are sometimes two sides of the same coin...

one scenario as to why shorter term rates might be higher than longer term rates is if short term break-even-inflation (BEI) is higher than longer term BEI. This could be if investors expect a recession with lower future inflation or even deflation...
Keep calm and Boglehead on. KCBO.

User avatar
BuyAndHoldOn
Posts: 199
Joined: Mon Mar 30, 2015 6:51 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by BuyAndHoldOn » Thu Jan 04, 2018 12:43 pm

Here is what the NY Fed makes of the Yield Curve (Updated 03-Jan-2018)

https://www.newyorkfed.org/medialibrary ... ob_Rec.pdf

grok87
Posts: 8509
Joined: Tue Feb 27, 2007 9:00 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by grok87 » Thu Jan 04, 2018 1:17 pm

BuyAndHoldOn wrote:
Thu Jan 04, 2018 12:43 pm
Here is what the NY Fed makes of the Yield Curve (Updated 03-Jan-2018)

https://www.newyorkfed.org/medialibrary ... ob_Rec.pdf
Thanks
So based on 3mo-10 yr spread their model suggests a 12% chance of recesssion which is basically the same level it reached just before the 2001-2003 recession
Keep calm and Boglehead on. KCBO.

JBTX
Posts: 4262
Joined: Wed Jul 26, 2017 12:46 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by JBTX » Thu Jan 04, 2018 8:06 pm

One answer could be that the Fed primarily controls short term rates while other market forces tend to drive long term rates. The fed pushing up short term rates causes some fear of economic softening which tends to favor long term bonds vs stocks. This is just a variant on what some others have said here.

User avatar
whodidntante
Posts: 4319
Joined: Thu Jan 21, 2016 11:11 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by whodidntante » Thu Jan 04, 2018 8:36 pm

On CNBC I heard that the shedding of the balance sheet will cause treasuries to yield more, thus preventing inversion. They use colorful graphics and talk loudly, and I don't see that kind of quality here, so they must be right.

User avatar
patrick013
Posts: 2430
Joined: Mon Jul 13, 2015 7:49 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by patrick013 » Thu Jan 04, 2018 8:57 pm

If the yield on 2 consecutive 2 year bonds (estimated) was
higher than the yield on a 5 year bond we'd have an invert
for awhile.
age in bonds, buy-and-hold, 10 year business cycle

gclancer
Posts: 564
Joined: Sat Apr 27, 2013 10:34 am

Re: Conceptually: *Why* does the Yield Curve invert?

Post by gclancer » Thu Jan 04, 2018 9:18 pm

whodidntante wrote:
Thu Jan 04, 2018 8:36 pm
They use colorful graphics and talk loudly, and I don't see that kind of quality here, so they must be right.
+1

User avatar
BuyAndHoldOn
Posts: 199
Joined: Mon Mar 30, 2015 6:51 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by BuyAndHoldOn » Fri Jan 05, 2018 5:59 pm

I appreciate the continued dialogue above ^^^.


I heard the following points in the last ~5 minutes of the show linked below:
https://www.bloomberg.com/news/audio/20 ... ilvia-says

1. As credit/financial conditions "tighten" - such as, when short term interest rates rise and come closer to longer term rates (curve flattening) - banks have less of an incentive to lend and extend credit, including rolling over [renewing] debt. This means struggling firms that rely on credit to survive will go bankrupt and start causing economic distress. --> Makes sense that the Fed wants to avoid a yield curve inversion/severe curve flattening, even if much of that is an effect of Monetary Policy in other parts of the world and not [necessarily] a reflection on the US economy.

2. Financial conditions are pretty loose right now even with a flat-ish yield curve, since the amount that banks pay depositors ("deposit beta") is still very low. Meaning: Banks still earn a spread on their 0% short term borrowing [from depositors] and longer term lending.

3. The Fed/Fed Funds Rate controls - per the guest, Alessio de Longis - the 3 month treasury. He believes market forces have driven up the yields at the 2-year range. My inference is that: the bond market expects more rate hikes in the near term, but after that (post ~3-5 years): Not much else. This gets into the Low Term premium brought up by lack_ey [per my understanding]: without higher inflation, and/or GDP expectations, investors are willing to lock in rates of return at the long end without much [additional] compensation.

Thesaints
Posts: 1664
Joined: Tue Jun 20, 2017 12:25 am

Re: Conceptually: *Why* does the Yield Curve invert?

Post by Thesaints » Fri Jan 05, 2018 7:17 pm

Methinks investors are "forced" to take longer term rates, as unexciting as they are, in the attempt to keep their allocation to bonds large enough.
It is the same reason why high-yield market is so crowded.
Also, you can't "lock-in" shorter term rates; it is the definition of "short term".

ThrustVectoring
Posts: 585
Joined: Wed Jul 12, 2017 2:51 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by ThrustVectoring » Fri Jan 05, 2018 8:40 pm

It's because the market expects future short-term rates to go down. That's the short story. If you ignore credit risk and talk about the treasury yield curve, you can guess that most strategies are about as attractive as any other.

In typical market conditions, short-term rates are expected to stay the same, and the term premium for long-term bonds represents the option value of having short-term investments - if another opportunity comes up or if market conditions change, it's far better to have short-term investments, so the short-term bonds represent significantly more option-value.

If the market expects short-term rates to go up in the future, it makes long-term bonds relatively less attractive, which means a higher yield is necessary to clear the market, which increases the spread. On the flip-side, if the market expects short-term rates to go down in the future, it makes long-term bonds relatively more attractive, which means buys drive down the yield of long-term bonds, driving the spread down.
Current portfolio: 60% VTI / 40% VXUS

User avatar
beyou
Posts: 2094
Joined: Sat Feb 27, 2010 3:57 pm
Location: Northeastern US

Re: Conceptually: *Why* does the Yield Curve invert?

Post by beyou » Fri Jan 05, 2018 9:43 pm

Another way to think of this is as if short term and long term bonds are two different asset classes almost.
Short term bonds are good if you are investing for short term obligations or betting on inflation.
Long term bonds are for longer term goals and hedges against deflation.

So when people are concerned about deflation, buy long term bonds.
If you are concerned about inflation, buy short term bonds (or TIPS of course).
So naturally one will become more valuable than the other based on investor aggregate concerns.
And yields are an expression of price, inverse of price.

So this is like asking why one has a higher price than the other. Because people bid one or the other higher.

User avatar
bobcat2
Posts: 5247
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

Re: Conceptually: *Why* does the Yield Curve invert?

Post by bobcat2 » Fri Jan 05, 2018 10:33 pm

The OP linked to Greg Mankiw's explanation of the inverted yield curve, but apparently didn't follow the explanation Mankiw gave. Here is my way of expressing Mankiw's explanation, which seemed succinct and correct to me.

The yield curve inverts when investors expect short-term interest rates to decline. At that point they are willing to hold long-term bonds, despite the lower current yield, because they are locking in that current long yield, which they expect to decline in the near future. Keep in mind that prevailing long rates reflect both present short rates and also expected future short rates. When investors are expecting short rates to fall markedly in the near future, long rates will be below current short rates.

Short rates are set by the Federal Reserve. So when the yield curve is inverted, investors are probably expecting the Fed to be loosening monetary policy (by lowering short-term interest rates) in the near future. Investors expect the Fed to be loosening because investors believe that economic growth is slowing.They then expect the Fed would react to an expected economic slowdown, or possible oncoming recession, with looser monetary policy in the near future in order to stimulate overall demand. That perception of an upcoming economic slowdown leads to an inverted yield curve today. That's why a negative sloped yield curve is considered an indicator of a possible recession on the horizon.

To answer one of the OP's concerns, you can't lock in a short-term rate. If you can lock-in a rate over time, it's not a short-term rate.
OP wrote:
If short term rates are higher than long-term rates, wouldn't you want to "lock in" the HIGHER rates that are available with less duration?


Like Greg Mankiw, Paul Krugman is also a good expositor of basic economics. Here's Krugman's very Mankiw like explanation of the negative yield curve and what it portends.
The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut [short-term] rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

rgs92
Posts: 2280
Joined: Mon Mar 02, 2009 8:00 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by rgs92 » Fri Jun 15, 2018 2:10 pm

So I noticed today that the 10 year bond yield is only one tenth of one percent lower than that of the 30 year bond.
(And the 2 year rate is only a half-percent less.)
Would this mean that the yield curve may go flat or invert?
Does this meant that the common wisdom that interest rates are on the rise and bonds are not a good investment now is wrong?
Thanks.

jebmke
Posts: 8467
Joined: Thu Apr 05, 2007 2:44 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by jebmke » Fri Jun 15, 2018 2:39 pm

The term premium from 5 to 30 has been hovering below 1bp per year - virtually flat.
When you discover that you are riding a dead horse, the best strategy is to dismount.

User avatar
BuyAndHoldOn
Posts: 199
Joined: Mon Mar 30, 2015 6:51 pm

Re: Conceptually: *Why* does the Yield Curve invert?

Post by BuyAndHoldOn » Fri Dec 07, 2018 12:04 pm

One key concept I was missing when I started this thread: What a Bond (series of payments) really is.

If the investor is worried about yields falling (economic softness, or whatever): You can "lock in" a longer stream of payments by buying a longer duration bond at a yield that is similar or even lower than what a shorter-duration bond would offer. Say you had the choice of a 2-year bond yielding 3% and a 10-year bond yielding 2.9%. You will earn a higher return for years 1-2 with the 2-year bond, but then: That's it. You have to reinvest your principal (bond maturing) at a lower yield, whatever that may be. But with the 10-year bond: No reinvestment risk, you keep that 2.9% stream of payments for as long as the bond lasts.

Post Reply