Pete ThoresonMaybe its just the news outlets that I tend to listen to, but it seems lately like hardly a day or two goes by and there's not a piece focused on the "Yield Curve" and its potential to invert! While terms like "2's of 10's" has become somewhat background to me, I've had some clients inquire on the topic and realize it is a bit Greek to the average reader (also maybe a bit drab I'm afraid).
The first thing to understand is what Yield is? Yield is a function of a bond's interest rate (annual rate normally) divided by its current price. When you initially buy a newly issued bond, the Yield and the Interest Rate are equal. While the interest rate normally stays fixed, the yield will drift over time. While this can sound confusing...its easier to follow with an example:
If you were to loan a friend $100, maybe if he/she were a good friend, you would do it for free (0% rate / 0% yield). Yet if not a good friend, you would either charge an interest rate or expect this friend to pay one. Let say after a week your friend gave you $110 for your trouble. That's 10% of your money over one week! But what if he didn't pay you back for a month or a year? Would $10 still sound good? Probably not as good, and that's why longer-term loans demand a higher rate of return.
What's going on with today's interest rates...are like above where the interest rates for long term are getting close to equaling short term rates. There are many forces behind this, but when this happens or moreover when short term rates pay even higher interest than long term rates, this is known as an inversion (shorter rates > longer rates).
Why it's a big deal is because its rare (doesn't happen very often) and every time in history that this has occurred, it has been an indicator of an upcoming recession. Hence Wall Street is watching and as always, worried.
Like all things these days, there are graphs for everything, and Bond Yields are certainly no exception. If you Google "bond yield 2s and 10s" you will get lots of options to view this history yourself.
Having said all of this, does a recession mean the same thing as stock market decline....... not necessarily....so don't be hasty in jumping on the "inversion bandwagon."
