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In finance, an inverted yield curve happens when a
In finance, an inverted yield curve happens when a yield curve
In finance, the yield curve is a graph which depicts how the yields on debt instruments - such as bonds - vary as a function of their years remaining to maturity. Typically, the graph's horizontal or x-axis is a time line of months or ye ...
graph of typically government bond
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity dat ...
s inverts in the opposite direction and the shorter term US Treasury bonds are offering a higher yield than the long-term Treasury bonds. Longer maturity bonds usually have a higher percent yield return because they are more risky because of volatility in the market
Market is a term used to describe concepts such as:
*Market (economics), system in which parties engage in transactions according to supply and demand
*Market economy
*Marketplace, a physical marketplace or public market
Geography
*Märket, an ...
, there could be a Liquidity trap that wouldn't allow an investor to sell the bond security" \n\n\nsecurity.txt is a proposed standard for websites' security information that is meant to allow security researchers to easily report security vulnerabilities. The standard prescribes a text file called \"security.txt\" in the well known locat ...
on the secondary market over the long run and they could get stuck with an underperforming asset. The inverted yield curve is one of the most reliable leading indicators for economic recession
In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
since at least 1955. The US Federal Reserve
The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
uses open market operations to adjust the Federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis. Reserve balances a ...
which pushes up short term bonds to catch the longer maturity bonds which are rising to catch up to inflation during the flattening of the yield curve. The inversion of the yield curve tends to predate a recession 7 to 24 months ahead of time.
History
The term 'inverted yield curve' was coined by the Canadianeconomist
An economist is a professional and practitioner in the social science discipline of economics.
The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...
Campbell Harvey in his 1986 PhD thesis at Duke University.
Business cycles
The inverted yield curve is the contraction phase in thebusiness cycle
Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examin ...
or credit cycle The credit cycle is the expansion and contraction of access to credit over time. Some economists, including Barry Eichengreen, Hyman Minsky, and other Post-Keynesian economists, and some members of the Austrian school, regard credit cycles as the f ...
when the federal funds rate and Treasury interest rates are high to create a hard
Hard may refer to:
* Hardness, resistance of physical materials to deformation or fracture
* Hard water, water with high mineral content
Arts and entertainment
* ''Hard'' (TV series), a French TV series
* Hard (band), a Hungarian hard rock supe ...
or soft landing Soft landing may refer to:
*Soft landing (aeronautics)
A soft landing is any type of aircraft, rocket or spacecraft landing that does not result in significant damage to or destruction of the vehicle or its payload, as opposed to a hard la ...
in the cycle. When the Federal funds rate and interest rates are lowered after the economic contraction
In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...
(to get price and commodity stabilization) this is the growth and expansion phase in the business cycle. The Federal Reserve only indirectly controls the money supply and it is the banks themselves that create new money by fractional-reserve banking
Fractional-reserve banking is the system of banking operating in almost all countries worldwide, under which banks that take deposits from the public are required to hold a proportion of their deposit liabilities in liquid assets as a reserve, ...
when they make loans. By manipulating interest rates with the Federal funds rate and repurchase agreement
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two pa ...
(repo market) the Fed tries to control how much new money banks create.
Other countries inverted yield curve
Yield spreads
Yield spread
Yield may refer to:
Measures of output/function
Computer science
* Yield (multithreading) is an action that occurs in a computer program during multithreading
* See generator (computer programming)
Physics/chemistry
* Yield (chemistry), the amo ...
is the difference between the quoted rates of return
In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment, such as interest payments, coupons, ...
on two different investments
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing is ...
and for the inverted yield curve it is United States Treasury Bonds. It is simply done by subtracting the percent yield on one bond vs another bond of a different duration. For example a 30 year bond with a 6% yield minus a 2 year bond with a 4% yield would be a spread of 2% or 200 basis points
A basis point (often abbreviated as bp, often pronounced as "bip" or "beep") is one hundredth of 1 percentage point. The related term ''#Permyriad, permyriad'' means one hundredth of 1 percent. Changes of interest rates are often stated in basis ...
. Another example would be a longer duration bond of 10 years at 3% minus a shorter duration bond of 3 months at 3.5% would be -0.5% or a negative yield spread.
See also
* Austrian business cycle theory *Friedman's k-percent rule
In macroeconomics, Friedman's k-percent rule (named for Milton Friedman) is the monetarist proposal that the money supply should be increased by the central bank by a constant percentage rate every year, irrespective of business cycles.
Definit ...
*Zero interest-rate policy
Zero interest-rate policy (ZIRP) is a macroeconomic concept describing conditions with a very low nominal interest rate, such as those in contemporary Japan and in the United States from December 2008 through December 2015. ZIRP is considere ...
*1970s commodities boom
The 1970s commodities boom refers to the rise of many commodity prices in the 1970s. Excess demand was created with money supply increasing too much and supply shocks that came from Arab–Israeli conflict, initially between Israel and Egypt. Th ...
*2000s commodities boom
The 2000s commodities boom or the commodities super cycle was the rise of many physical commodity prices (such as those of food, oil, metals, chemicals and fuels) during the early 21st century (2000–2014), following the Great Commodities Depress ...
*2020s commodities boom
The 2020s commodities boom refers to the rise of many commodity prices in the early 2020s following the COVID-19 pandemic. The COVID-19 recession initially made commodity prices drop, but lockdowns, supply chain bottlenecks, and dovish monet ...
References
{{United States – Commonwealth of Nations recessions Economics curves Bond valuation Yield (finance) Public finance Economy Government finances in the United States Government bonds issued by the United States Government bonds