HomeLatest ThreadsGreatest ThreadsForums & GroupsMy SubscriptionsMy Posts
DU Home » Latest Threads » Forums & Groups » Main » General Discussion (Forum) » YIELD CURVE INVERTS: Rece... » Reply #7

Response to SidDithers (Original post)

Wed Aug 14, 2019, 07:23 PM

7. Yield Curve explained...


Okay who wants a plain-language explanation of the inverted yield curve? I will do it if there's demand.
Okay I dedicate this to @ClaraJeffery, an excellent journalist who does not deserve to feel economics pain.
So first the context: Why the bond market tells you more about the economy than the stock market.

We all hear about the stock market every day. The S&P 500, the Dow Jones Industrial Average.

What is the stock market? Think of it as a literary device.
The stock market is a way that people tell short stories about companies.

So for instance: When a stock is up, people are telling positive stories about that company.

When a stock is down, people are talking smack about that company.
When the "stock market" is up: Well frankly that is meaningless. No one knows why it goes up or what it means.

When it goes down, yes everyone is cranky. But we still don't know why. It could be literally anything. It's never ONE thing.
So the stock market is actually a tiny fish. The big fish is the BOND market. TRILLIONS of dollars.

What are bonds?

They are how companies and governments borrow money.

Every bond is a contract that says "we'll pay you back with this interest on this date."
Bonds ALSO tell a story about a company or a government. But it's a BETTER story, a novel rather than a short story.

That's because selling stock is pretty casual but borrowing money requires a lot of proof and documentation.

Bond investors are SKEPTICAL.
Similarly, companies and governments that sell bonds don't want a lot of pikers who run around selling loans. They want people to stick around.
So, to lure people to buy bonds -- to lend money to a company or government -- and HOLD ON TO THEM, companies and governments promise a higher "yield" to people who promise to lend them money over a long time.
What is a long time? Let's call it at least 10 years. So if you buy a bond in which the company promises to pay you back over 10 years, you make MORE yield than people who only lend money for one year.
It's also good to lend money over 10 years. It shows you have faith the company or government will be in good shape in 10 years.
Now let's go to Treasury bonds. There are three important durations of US Treasury bonds: 3 months, 2 years and 10 years.
To be clear, that means investors are lending the US government money over 3 months, or over 2 years, or over 10 years.
The yields should *always* be higher on 10-year Treasury bonds. I mean, you're not seeing your money get paid back for 10 years! You should be compensated accordingly.
So that is the yield curve: It shows short-duration bonds with lower yields than the long ones.
HOWEVER. (dark music) Over the past few months, yields have been higher on the LOWER END.

So buying US Treasuries for only 3 months paid more than keeping them for 10 YEARS.
And today, briefly, you could make more money buying two-year Treasury bonds than 10-year ones.
This phenomenon of getting paid more for a short-term loan than a long-term loan to the US government: It is all upside down! It's inverted!

So why is this specifically bad news?

Well because when the yield curve is INVERTED, usually a recession follows within around two years.


That's been the case for the last 5 recessions. Inverted yield curve predicts recessions.
And that is why it bad news when there is an inverted yield curve.
I simplified this a lot, feel free to ask questions.

Reply to this post

Back to OP Alert abuse Link to post in-thread

Always highlight: 10 newest replies | Replies posted after I mark a forum
Replies to this discussion thread
Arrow 7 replies Author Time Post
SidDithers Aug 14 OP
CountAllVotes Aug 14 #1
MissB Aug 14 #2
2naSalit Aug 14 #3
Webhead Aug 14 #4
SidDithers Aug 14 #6
Johnny2X2X Aug 14 #5
LineNew Reply Yield Curve explained...
SidDithers Aug 14 #7
Please login to view edit histories.