What's an Inverted Yield Curve & why is it negative?

Answer 1

An inverted yield curve happens when long term rates are lower than short term rates. Investors are risk averse -- and demand a premium for taking on more risk. Usually, long term bonds are considered riskier than short term bonds -- because their prices fluctuate more when interest rates move.

So what could make people demand a higher yield for these seemingly less risky short term bonds?

It turns out that there are two kinds of risks associated with bonds. Price risk is the one most people think about. But there is also reinvestment risk. When the yield curve is inverted, people are more worried about reinvestment risk than they are about price risk -- and demand a premium for taking on short term bonds -- because they will have to reinvest that money sooner.

Now -- why is this bad that people are worried about a different kind of risk than usual? The theory that tells us why comes from some work by Doug Breeden -- who is about to step down as the Dean at Duke's business school.

Here is the idea: Suppose the economy has been doing well, and businesses are making money. If they think the economy is going to continue to do well, then they will invest their profits back into the firm. But if they think that the economy will slow down, they worry that investing in the firm will give them surplus inventories & cost them money. So, they take that money & invest in intermediate term Treasury bonds instead. Now if enough companies do this, it will mean that companies are no longer investing in growth -- so there is a self-fulfilling prophesy, and the economy will go into a recession.

Does this really happen? Yes! Another academic (also at Duke) is Campbell Harvey -- whose doctoral dissertation looked at what happens when the yield curve inverts. He was looking at the 3-month rate vs the 5-yr rate. He looked at many countries and went back to the 1700s. He found that whenever the 5-yr rate goes below the 3-month rate, a recession follows in three to five quarters. The predictive power was 100%. Not only that, but every time this has happened since his dissertation was published in the mid-1980s, a recession followed -- so his model works out of sample.

The WSJ and other news media claim that the predictive power of niverted yield curves is not perfect. However, they usually talk about the ten-yr being lower than the 2-year. They are right that that particular inversion is correlated with recessions, but does not predict them.

Answer 2

An Inverted yield curve means that short term bonds have higher interest rates then long term bonds...I'm not sure why it's a really bad sign but it is...

Answer 3

Aerodynamic body and forhead(theres a reason Airbus formed the A380' foreheadthat way). strengthen created type those huge wings and 80,000lbs of thrust in step with engine. each and each aspect coupled collectively receives it off the floor...