Kind Reminder:
In our introduction to yield curves, we noted that the idea behind the use of a Yield Curve is to measure investors’ perception of risk and future developments both in the bond market as well as in the overall economy. Short-term bonds should carry lower yields than longer-term ones because lending to someone for a shorter period of time is less risky for the investor. As such, Yield Curves should be positive.
This behaviour is referred to as the normal yield curve, which slopes upward from left to right on the graph as maturities lengthen and yields rise. This is the usual case in most instances throughout history.
However, there are times when the yield curve becomes steeper, inverted or flatter.
Inverted Yield Curve: In periods preceding recessions, the yield curve can actually invert, with short-term bonds offering higher yields than longer-term bonds. While this appears to be counterintuitive, there is a reason this makes sense: given that lower economic growth means lower yields then bond investors seek the safety of longer-term assets for their funds. As such, demand for these bonds increases and yields decline. Given that lower yields are associated with lower interest rates and lower interest rates are usually associated with slower economic growth, an inverted yield curve is often taken as a sign that the economy may soon stagnate.
However, since the last few days we have seen is US but also in Europe bonds, composing a steep yield curve, we decided to have this article and podcast in order to explain the other two types of Yield curve.
Last night, Wall street continued to firm up on optimism the virus might be plateauing, or that at least that the worst has been seen. With that in mind, there’s increasing hope the lockdowns might be ended sooner rather than later. Stock markets post some gains while Treasuries were mixed. Hence, the long end continued to underperform and steepening the curve out to 50 bps. But what does a steep yield curve means?
Steep yield curve is when the difference between the long-term and short-term bonds becomes larger. This usually occurs at the beginning of a period of economic expansion, following the end of a recession. At that point, short-term interest rates will likely be very low given that the Central Bank has lowered them to fight the recession. However, as the economy begins to grow again, many people believe that inflation will also follow suit. At this point long-term bond investors fear that they will be locked into low rates as a result of the until-then depressed rates. As a result, they demand higher rates and only commit to their funds if the long-term bonds increase their yields.
A steepening yield curve typically indicates that investors expect rising inflation and stronger economic growth.
What is a Flat Yield Curve?
Flat yield curve meanwhile, is slightly the opposite of Steep Yield curve.
A flattening yield curve is when the difference between the long-term and short-term bonds becomes smaller and smaller – curve becomes less curvy -flat. At this point, investors demand higher long-term rates to make up for the lost value because inflation reduces the future value of an investment. A flattening yield curve can also occur in anticipation of slower economic growth. Sometimes the curve flattens when short-term rates rise on the expectation that the Central Bank will raise interest rates.
This happens because rising interest rates cause bond prices to go down—when fixed-rate bond prices fall, their yields rise.
Disclaimer: Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of purchase or sale of any financial instrument.
Editors’ Picks
EUR/USD stays in positive territory above 1.0850 after US data
![EUR/USD stays in positive territory above 1.0850 after US data](https://editorial.fxstreet.com/images/Markets/Currencies/Majors/EURUSD/money-euro-and-dollar-banknotes-17371247_XtraSmall.jpg)
EUR/USD clings to modest daily gains above 1.0850 in the second half of the day on Friday. The improving risk mood makes it difficult for the US Dollar to hold its ground after PCE inflation data, helping the pair edge higher ahead of the weekend.
GBP/USD stabilizes above 1.2850 as risk mood improves
![GBP/USD stabilizes above 1.2850 as risk mood improves](https://editorial.fxstreet.com/images/Markets/Currencies/Majors/GBPUSD/strong-pound-weak-dollar-17536259_XtraSmall.jpg)
GBP/USD maintains recovery momentum and fluctuates above 1.2850 in the American session on Friday. The positive shift seen in risk mood doesn't allow the US Dollar to preserve its strength and supports the pair.
Gold rebounds above $2,380 as US yields stretch lower
![Gold rebounds above $2,380 as US yields stretch lower](https://editorial.fxstreet.com/images/Markets/Commodities/Metals/Gold/gold-gm187363896-28836378_XtraSmall.jpg)
Following a quiet European session, Gold gathers bullish momentum and trades decisively higher on the day above $2,380. The benchmark 10-year US Treasury bond yield loses more than 1% on the day after US PCE inflation data, fuelling XAU/USD's upside.
Avalanche price sets for a rally following retest of key support level
![Avalanche price sets for a rally following retest of key support level](https://editorial.fxstreet.com/images/Avalanche/Avalanche_XtraSmall.jpg)
Avalanche (AVAX) price bounced off the $26.34 support level to trade at $27.95 as of Friday. Growing on-chain development activity indicates a potential bullish move in the coming days.
The election, Trump's Dollar policy, and the future of the Yen
![The election, Trump's Dollar policy, and the future of the Yen](https://editorial.fxstreet.com/images/Macroeconomics/Events/US%20Elections/Donald_Trump_closeup_XtraSmall.jpg)
After an assassination attempt on former President Donald Trump and drop out of President Biden, Kamala Harris has been endorsed as the Democratic candidate to compete against Trump in the upcoming November US presidential election.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.