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Not quite that. The yield for a 5-year note is less than the yield for a 3-year note. More generally, a yield curve inversion is when the interest rate you ear
by bunderbunder 8y ago
Not quite that. The yield for a 5-year note is less than the yield for a 3-year note.
More generally, a yield curve inversion is when the interest rate you earn on short-term debt ends up higher than that of long-term debt of the same quality.
I don't think the issue is that the inversion causes the recession. It's more an indicator of pessimism in the market. It implies that investors think that interest rates are going to get worse, so they look to buy more longer-term bonds in order to try and lock in current yields for a longer period of time. That increases demand for those assets, which drives down their price^H^H^H^H^H yields.
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- throwaway4job 8y agoNot quite that. Bond prices go down when interest rates go up. As such, an investor who thinks that interest rates will go _up_ will reallocate from long-term bonds to short-term bonds, rather than the opposite as you stated.
- cloakandswagger 8y ago> That increases demand for those assets, which drives down their price. I'm not an economist but this seems wrong
- bunderbunder 8y agoHaha, gotcha. edited.
- vasilipupkin 8y agoyes, OP meant drives up the price and drives down yields
- halotrope 8y agoActually it does not drive down the price but the yield. When the price goes up the fixed payment is a lower fraction of the price of the bond. Hence the return goes down. https://www.investopedia.com/terms/b/bond-yield.asp https://www.investopedia.com/terms/b/bond-yield.asp
- cbdumas 8y agoHe made it most of the way there. Increasing demand drives UP prices, which drives DOWN yield.
- nwah1 8y agoThat commenter should've said the yield is driven down. The US government wants to borrow at the cheapest rate of interest. If more people want to lend to them, they have more options and can pick the cheapest option.
- User23 8y ago> The US government wants to borrow at the cheapest rate of interest This is categorically not true. If it were then Congress would pass legislation ordering the Fed to buy securities from the Treasury at whatever rate it liked (or abolish the Fed altogether and just directly spend money into existence). Congress in fact wants to provide savings vehicles, it's not actually necessary for Congress to borrow to fund the federal government. Sure it's necessary under current law but Congress by definition can change that law. That it chooses not to is an expression of a preference.
- helen___keller 8y agoDrives down their yield would be more correct, which is to say the asset becomes less profitable.
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- skiierskyer 8y agoThis was corrected above, but for those who are interested: For bonds, yield and price are inversely related. Buying a bond means you are lending money now, in return for more money later. The amount you get later is made up of the price you pay now plus the interest, ie the yield. So if the yield goes up, the price goes down. (You don't have to pay as much for a bond when the yield goes up).
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- madamelic 8y agoAh, so this is basically the market saying the US government's ability / willingness to pay debts today is greater than it will be in the future? Or is it simply about interest rates, I guess, since higher interest rates cool the market and lower interest rates warm the market. So investors are thinking a recession is coming and the Fed will need to lower interest rates to stimulate.
- bunderbunder 8y agoI don't think it's that - US Treasury Securities are always regarded as being nearly as safe as cash. But, in a recession, the stock market tends to nose dive, which prompts a lot of people to flee to fixed-income securities because they're viewed as being safer. Which would also drive down yields.
- madamelic 8y agoGreat, thanks for your help. I'm understanding much better now about how bonds are priced and how it relates to their yield. :)
- kgwgk 8y ago> US Treasury Securities are always regarded as being nearly as safe as cash Not always: https://en.m.wikipedia.org/wiki/United_States_federal_government_credit-rating_downgrades https://en.m.wikipedia.org/wiki/United_States_federal_govern...
- kbutler 8y agoFrom the page you linked: "Market consequences ... U.S. treasury bonds, which had been the subject of the downgrade, actually rose in price and the dollar gained in value against the Euro and the British pound, indicating a general flight to safe assets amid concerns about a European debt crisis.[31]" Basically, no one believes rating agencies with respect to the US paying its debts - but they do believe that if the US government is in chaos, it will be bad for the world economy. One should also remember that US bonds are denominated in US dollars, which the US government can print. Also, if you're comparing to "cash" you probably mean "US dollars" which are backed by the "full faith and credit" of...the US government.
- dv_dt 8y agoBut it's not just the bond market in isolation that is relevant, it's the possibility that money moving into longer term notes could mean that people are making bets that nothing in the overall market will yield more than the long term debt instruments.