Bonds, yields and the importance of inverting the yield curve: Yahoo U

<p class = "canvas-atom-canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "On August 14th, a part under close supervision of & nbsp;inverse yield curve, crushing the stock market for its worst day of 2019. The yield curve is a powerful predictor of an economic downturn; an inversion preceded each of the last seven recessions dating back to 1969. "data-reactid =" 15 "> On August 14, a closely guarded portion of the yield curve was reversed, dragging the stock market into its worst day of 2019. The yield curve is a powerful predictor of an economic slowdown: one inversion preceded each of the last seven recessions dating back to 1969.

While the yield curve has proven itself, it is by no means a cause of financial crisis and does not share any insight into the timing and magnitude of a recession. And some say in this case, a recession may never happen at all.

To understand the yield curve and why it has become a sign of a darker economic period, we need to understand the bond market and how cash returns are calculated.

<h2 class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Bonds: demand up, yields down?"data-reactid =" 18 ">Bonds: demand up, yields down?

Bonds are a class of assets different from stocks.

The market value of a company's stock is quite simple; the price goes up and down depending on the demand.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "But look for a government loan (like the & nbsp;10 years& nbsp; or & nbsp;30 years& nbsp; Cash) and you will find that the "price" of the bond is indicated in the form of "yield" and as a percentage. "data-reactid =" 21 "> But look for any government bonds (like the Treasury or 30 years) and you'll find that the" price "of the bond is indicated as" yield "and as a percentage .

Unlike equities, bonds issue coupon payments at regular intervals (and are therefore considered as "fixed income").

For example, a 10-year US Treasury that has a price of $ 1,000 (also called "face value") will issue coupon payments up to the date of the bond (in this case , 10 years). The US government pays these coupons to reward investors willing to bet on its debt.

These coupon payments therefore determine the payment of the holding of this obligation. So, if the coupons total $ 50 each year, the "yield" of the bond is $ 50 / $ 1,000, or 5%.

But these bonds are traded on the secondary market and a person may be willing to buy the bond from the investor at a higher price. A person who pays $ 1,200 for the bond will still raise $ 50 each year, which means that the actual return on the same bond is now $ 50 / $ 1,200, or about 4.2%.

In this case, the demand for the bond increased the underlying value of the bond, but actually decreased the yield. Conversely, if the demand for a bond is low, its underlying price will decrease but the effective yield will increase.

Thus, when we look at a bond's quoted market performance, lower returns actually mean higher demand and higher returns actually mean lower demand.

<h2 class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "The curve: from one month to 30 years"data-reactid =" 28 ">The curve: from one month to 30 years

In the United States, bonds are available for many durations, short term (one month) and long term (30 years). Because of the duration of government bonds, economists tend to consider the returns of different Treasury securities as a measure of expectations over different time horizons.

By plotting secondary market returns on Treasuries, we get the "yield curve" which, in normal times, tends to increase.

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Indeed, investors generally perceive public debt as a safe haven asset and a relatively risk-free asset. As a result, it offers a lower return than other categories of riskier assets such as equities. And among government bonds of different maturities, demand (and therefore returns) is lower in long-term bonds, as investors would prefer to find more lucrative investments than to be trapped for 30 years in a securities offering. a relatively low return.

But the curve changes shape when investors start to worry. If the economic outlook looks bleak, investors can move their investments out of riskier asset classes, such as equities, and reallocate money to "safe haven" assets, such as bonds (or l & # 39; gold).

Since the beginning of 2019, this is what is happening for US bonds across the curve. Short and long-term bond yields have fallen under the effect of global inflows into US fixed-income securities, fears of a slowdown in Europe and China pushing investors to stock their money in US public debt.

<h2 class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Inversions and recessions"data-reactid =" 54 ">Inversions and recessions

Demand for long-term bonds outperformed demand for short-term bonds, reducing long-term bond yields to a greater extent than short-term bond yields. Investors are more closely watching the 2-year bond (short-term bond) and 10-year (long-term bond) markets as they are among the most liquid US Treasury markets.

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