Yield Curve: What is it and why is it important?

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A reversal of the yield curve occurs when long-term bond yields are lower than short-term bond yields. This rarely happens. Prior to this month, this section of the yield curve had not reversed since 2007, just before the Great Recession.

The reversals of the yield curve are among the moments in the markets that attract everyone's attention.

Indeed, inversions of some parts of the yield curve have often been predictors of US recessions. It is not normal for investors to demand higher rates on short-term loans, supposed to be less risky.

People who buy bonds actually lend money to whoever sells them – the US government, in this case. Loans must be repaid as opposed to equity investments. In general, when investors are frightened, they extract money into shares and put it into bonds.

When investors get really scared, they demand higher rates to lend money, even for short periods. That's what's happening now.

Bond prices and the interest rates they pay are moving in opposite directions. When the demand for a bond is high, prices rise and the interest rates paid by these bonds decrease.

Investors have invested money in the security of US bonds because of the slowdown in the global economy. But they invest more in long-term bonds than in short-term bonds, thus reducing long-term yields. Last week, the 30-year US Treasury yield fell below 2% for the first time in its history.

Of course, what happens in the bond market is significant.

The inverted yield curves preceded each US recession of the modern era.

But inversion does not mean that a recession is imminent. The recessions took place on average 22 months after the last five reversals of the yield curve, according to Goldman Sachs.

Investors continued to invest in bonds, although they were promised a minimal rate of return – or, in the case of some bonds of other large developed markets, no return. Germany has sold for the first time this week a debt of 30 years to a negative return, which shows how worried investors are.
Concerns over the slowdown in the global economy have raised new fears of a slowdown in the United States, particularly in the light of the trade war with China.

While an inverted yield curve does not necessarily cause a slowdown, turbulence in the bond market may end up becoming a self-fulfilling prophecy as it undermines investor and corporate confidence.

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