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Fixed Income Corner

Learn the basics of investing in bonds/ bond funds and the role they play in an investment portfolio.

Yield Curve

The yield curve is a line graph that plots the relationship between yields to maturity and time to maturity for bonds of the same asset class and quality.


Implication of yield curve on the economy

The slope of the yield curve is not only a good reference for the bond investment strategies, but also a trustworthy leading indicator of economic activity.

There are three main types of yield curves: normal (upward sloping), flat and inverted. In general, economists concur that the slope of the yield curve depends on the investor’s expectations on the interest rates and risk premium.

A normal (upward sloping) yield curve appears under a normal market situation. It has often preceded an economic upturn and the rise of interest rates. Against the backdrop of economic growth, the associated risks of higher inflation and higher interest rates would escalate, which can both hurt bond returns. As such, investors demand more yield as maturity extends.

A flat yield curve is one in which the shorter- and longer-term yields are very close to each other. It is unusual and typically indicates a transition to either economic growth or recession.
 

An inverted yield curve can be an indication of economic recession. When yields on short-term bonds are higher than those on long-term bonds, it suggests that investors expect interest rates to decline in the future, usually in conjunction with a slowing economy and lower inflation. Historically, the yield curve has become inverted in 12 to 18 months before recession.

 

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