I . What Is an Inverted Yield Curve?
An inverted yield curve describes the unusual drop of yields on longer-term debt below yields on short-term debt of the same credit quality.
Sometimes referred to as a negative yield curve, the inverted curve has proven in the past to be a relatively reliable lead indicator of a recession.
- The yield curve graphically represents yields on similar bonds across a variety of maturities.
- An inverted yield curve occurs when short-term debt instruments have higher yields than long-term instruments of the same credit risk profile.
- An inverted yield curve is unusual; it reflects bond investors' expectations for a decline in longer-term interest rates, typically associated with recessions.
- Market participants and economists use a variety of yield spreads as a proxy for the yield curve.
II . Understanding
The yield curve graphically represents yields on similar bonds across a variety of maturities. It is also known as the term structure of interest rates. For example, the U.S. Treasury daily publishes Treasury bill and bond yields that can be charted as a curve.
Analysts often distill yield curve signals to a spread between two maturities. This simplifies the task of interpreting a yield curve in which an inversion exists between some maturities but not others. The downside is that there is no general agreement as to which spread serves as the most reliable recession indicator.