Bond Yield Curve-Application

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ThisDinosaur
Posts: 997
Joined: Fri Jul 17, 2015 9:31 am

Bond Yield Curve-Application

Post by ThisDinosaur »

How reliable is the Treasury Yield Curve in predicting recessions? What is the causal connection between the yield curve and the recession that follows?Do you use it to make investment decisions?

This is my understanding so far:
A normal yield curve shows longer maturity bonds having higher interest rate as a premium for locking up your money longer. An inverted yield curve shows long term rates being lower than short term. This is interpreted as meaning that investors-in-aggregate think interest rates are going to be lower in the future, so they'd better lock in higher rates now rather than have to reinvest their short term bond principle at a lower interest rate in the future.

The other narrative I've seen is that the Fed raises the fed funds rate when they see an asset bubble in order to curtail overinvestment. This raises the short term treasury yield higher than the existing long term rate. The bubble pops (either as predicted or *because* the fed offered more appealing return in bond interest) and the recession occurs.

What information do I need to proceed to the next wheaton level on this?

Dragline
Posts: 4436
Joined: Wed Aug 24, 2011 1:50 am

Re: Bond Yield Curve-Application

Post by Dragline »

It may be more correlation than causation. But a flat or inverted yield curve means that people are less confident about the future returns of risky assets. Its a pretty reliable indicator, although often in hindsight.

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