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Thats not how it works. If 5-year bond has yield x, for principal P you receive Px for 5 years. With 3-year bond with yield y, you get Py for 3 years. If y > x
by anilshanbhag 8y ago
Thats not how it works. If 5-year bond has yield x, for principal P you receive Px for 5 years. With 3-year bond with yield y, you get Py for 3 years. If y > x => after 3 years rates will be lower than y. So you will get lower than P*y for the last 2 years (of 5 years).
- jstanley 8y agoAhh, got it. So the overall yield is not lower, just the annualised yield. That doesn't sound like nearly as much cause for alarm.
- village-idiot 8y agoIt's not a cause for alarm per se, but the inverted yield curve means that the bond market is feeling pessimistic. Rate inversions often happen before recessions, but they're not a fool-proof indicator.
- adw 8y agoThe alarm is that bond yields are more or less `yield = (k / economic confidence)` - if people are confident then they don't buy bonds, so the price of bonds falls, so the yield (which is annualized return) rises. (Thus recessions lead to falling interest rates as people seek safe harbors for money, making credit cheaper.) What this means is that the bond market thinks available bond yields for cash-on-hand will be lower in three years than five, so they're willing to take a hit now to lock in the longer-term payout. That reflects serious economic pessimism.
- twic 8y agoWhich is why i think that describing the yield curve in terms of rates of bonds running from now until some date in the future (which is what we do when we talk about raw treasury rates, or zero-coupon bond rates, another common form) is really unhelpful, because it disguises this structure. We should instead talk about it in terms of expected instantaneous, or at least short-term, forward rates. For example, what is the expected rate for a three-month T-bill starting 1, 2, 3, 4, or 5 years from now?