Highlights

  • A yield curve plots interest rates and maturity of same quality bonds

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Explained: Recession risks and why should we care about an inverted yield curve

Bond and bond yields are inversely proportional to each other, meaning that when the demand for a specific bond rises, its yield drops.

Economists have been citing the inverted yield curve a lot these days as they predict a possible recession. But what is inverted yield and how does it predict a recession?

First, we will understand what is yield.

A yield is a return that a bond investor gets. Bond and bond yields are inversely proportional to each other, meaning that when the demand for a specific bond rises, its yield drops.

Basically, high demand means low yields; low demand means high yields.

In a normal case, yields on longer-term maturity bonds are higher than that of shorter-term bonds.

An inverted yield curve is a situation when the yields on short-term debt become more than the long-term debt.

In an easy language, this reflects a shift in demand from short-term credit to long-term credit. This happens when the big money sees riskier conditions in the near term. Hence, reflecting a recession or an economic downturn in the upcoming months.

This conversation comes into the spotlight as in the US the 2-year rate jumped more than 10 basis points to 3.1535%, reaching its highest level since 2007 inching towards the benchmark 10-year Treasury yield at about 3.1762. Just ahead of the Fed meet the yields are starting to signal at the economic winter is just around the corner this summer.

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