Inverted Yield Curve

Brian Milner

The Globe and Mail

Published Tuesday, Feb. 09, 2016 5:53PM EST

Last updated Tuesday, Feb. 09, 2016 5:54PM EST

What is an inverted yield curve?

Simply put, the yield curve shows the relationship between short-term interest rates and those for longer-term debt. Typically, investors demand higher rates for the increased risk of holding bonds or other debt instruments for longer periods, which means the yield curve slopes upward.

When the difference between short and long rates narrows, the curve starts flattening. And when short-term rates move higher than intermediate and longer rates, the normal pattern is reversed, or inverted.

What does it tell us?

The yield curve is an important gauge of economic and financial market health. When the slope of the curve steepens, it signals that investors – and businesses – are more confident about acquiring assets other than safe government bonds in an improving economy.

A flattening curve is a sign that investors are losing confidence in the growth story. And when it inverts, investors are battening down the hatches in expectation of future storms.

What does an inverted curve mean for the economy?

Nothing good. Inversions have preceded the past seven recessions, typically by about a year to 18 months. When the curve flattens or inverts, trouble is usually lurking in the neighborhood in the form of more costly financing for banks and other companies that typically borrow their money at short-term rates. It also means lower returns for pension funds and other investors that need to hold longer-term bonds. And even if the economy manages to muddle through, slower growth will translate into reduced corporate profits and lower returns for equity investors.

Comments by JustSignals

 Ok, so why post this?  This week the Chairperson Yellen of the Federal Reserve was asked about Negative Interest Rates (NIRP) and if the Fed was considering NIRP.  Yellen said that the Fed looked into NIRP during 2010 and that they were looking into it again now.  Not that NIRP was on the table, but, it is not off the table either.

Over the last 10+ years investors have been buying up US Treasury Bonds and thereby pushing down the yield on those Bonds.  Investors will do this as a flight to quality.  So, is the long term rates eventually going to be lower than the short term rates?   If Investors keep buying up those US Treas Bonds like they have been, maybe. Especially since the Fed just raised interest rates by 1/4 point those the rate spreads will get pretty tight.

So is this one of the reasons the Fed is considering NIRP?   

To keep the yield curve from inverting by manipulating it ?

To keep kicking the can down the road some more ?

If it is, now we should understand why NIRP has not worked in other countries and will probably not work here too.

The Currency Wars continue.

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