Hey, this is a most important article which worth reading. By the end of this article, you are going to learn about complete details about The Inverted Yield Curve which considered as the important recession indicator. Let’s get started
What is a Yield Curve?
Yield is the amount of cash which is paid to the investor in the form of dividend or interest by the security in which he invested. Here the security may be bond, debentures or equity.
After plotting the interest rates on a graph we will end up with a line which is called as Yield Curve.
In the above picture, I plotted the 10-year bond interest rate of the year 2007. After watching that picture I hope you got the clear idea of Yield Curve. Now let us dig deeper to find how this can act as a recession indicator. But before advancing further it is better to know types of Yield Curves.
Types of Yield Curves
There are three types of Yield Curves. They are
- Normal Yield Curve
- Inverted Curve
- Flat Yield Curve
Normal Yield Curve
In the normal yield curve, the securities having a more maturity period pays more interest to investors while the one with less maturity period gives less.
A 2-year bond which pays 1% and 10-year bond which pays 3% interest is an example of normal yield and curve will be similar to the one in the above picture.
In simple terms, the short term rate of interest < long term rate of interest and this indicates a stable form of economy.
Inverted Yield Curve
This is the opposite of Normal Yield Curve where the interest rate of short term bonds will be higher than long term bonds. That means the one who invested in short term bonds or treasury bills will be benefited more than long-term investors. This kind of inversion is not good for the economy and whenever this form it indicates an upcoming recession.
Flat Yield Curve
In this, the curve will be a straight line. It forms usually in two conditions
- When economic condition slows down after a rapid growth i.e, after the formation of Normal Yield Curve.
- When the country economy is recovering from a crash or a recession i.e, after the formation of Inversion Yield Curve
So How Yield Curves indicate the upcoming recession?
The above picture represents a graph comparing Yields rates of 10-year and 2-year bonds. Whenever interest on short term bonds paid higher than long term bonds, an inversion yield curve formed which you can observe in circles. After the formation of the inversion yield curve, the country economy went through the recession. The recent Yield Curve Inversion took place at the end of the year 2018 and it is the third circle in the above graph indicating the recession in the future.
Inversion Yield Curve indicated the 2001 and 2008 recessions a
It may take 1 to 2 years after the formation of the inverted yield curve for the country to face the recession. So this curve acts as a leading economic indicator.
In the next article below topics will be covered
- Who hikes interest rates and why?
- Other indicators of Recession.
- How to Prepare for it?
- How to find opportunities during the crisis
You can read more at https://www.thebalance.com/what-is-a-recession-3306019
You may find the solution for the recession in this article –
If you want to learn the relationship between Interest rates and Recession, CLICK ME
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