Why this is bad news for economic growth and inflation

Kameleon007 / iStock.com

Financial news has been rife with updates on the Treasury yield curve reversing between 20 and 30 last Thursday – but what does that mean, and how could it affect you?

The US Treasury Department finances federal government debt (commonly known as “bonds”) by issuing its own forms of debt. This means treasury bills and the $ 14.8 trillion treasury “market” include everything from treasury bills, T-notes and bonds at 20 and 30 years.

How to buy bonds: A beginner’s guide to investing
Actions against bonds: How to choose the best investments

Investors of all kinds can buy these instruments, and each has its own function. Treasury bills, or treasury bills, have maturities ranging from one month to one year. Treasury bills, T-notes, have maturities of 2 to 10 years and treasury bills have maturities of 20 or 30 years.

The “yield curve” plots the yield on all of these treasury securities, and investors watch its “shape” to estimate movements and market conditions for everything from interest rates to monetary policy.

U.S. Treasury bonds are considered one of the safest investment products in the world, and international markets use their value and movements as a benchmark for economic security – or volatility. The 10-year Treasury bond is considered the benchmark for most 10-year bonds on the market. All US Treasury bonds are secured by the full confidence and credit of the US government, as the country has not yet defaulted (even though we get uncomfortably close) on its creditors, making it one of the most creditworthy nations in the world.

Economy explained: What you need to know about the inverted yield curve and economic issues

Your typical yield curve looks like any ordinary scatter plot – as values ​​increase on the x-axis, values ​​on the y-axis increase as well.

The curve generally tilts upward, as “investors expect more compensation for the risk that rising inflation will reduce the expected return on longer-term bond holdings,” according to Reuters . This means that treasury bills, which expire quickly, will earn – or give you back – a small amount of money. You take little risk compared to other investors because you hold the security for a short time. Investors prefer these kinds of investments if they want to park the money somewhere and be sure to get it back. They also pay a fixed interest rate, which is usually very low.

The most important concept to remember in the bond space is the inverse relationship between interest rates and bond prices. But why?

Bonds pay a fixed interest rate. It may be beneficial for investors to lock in an interest rate if they think the interest rates will go down, because the rates will go down but they will continue to charge a higher interest rate on their already purchased bond. This increases the demand for higher yielding bonds, thus pushing up the price. If interest rates rise, lower yielding bonds will become less attractive, as investors will favor higher yielding bonds paying certain higher interest rates. This will cause the price of bonds to drop.

Problems in the system

Over the past two decades, the yield curve has occasionally inverted, a phenomenon Reuters called “bad news for the near-term economic outlook” and a harbinger of past recessions.

Statistic: US Treasury Yield Curve in October 2021 |  Statistical

Statistic: US Treasury Yield Curve in October 2021 | Statistical

Source: Statista

Normally, as shown in the image above, the yield of the 30-year bond would be higher than that of all other bonds because it has a longer time horizon. On Thursday, however, the yield on the 20-year bond exceeded that of the 30-year bond.

Following: Recessions Explained: Definition, Warning Signs and What Happens During One?

In finance, this is called a “flattening” of the curve or an “inverted” curve, basically because it does not behave as it theoretically should. Instead of the relatively smooth upward trajectory of the yield line (which curves slightly, hence the name), a ‘dip’ occurred last week that ruined or ‘reversed’ the trajectory to the right. and up on the axes.

Why is this happening now?

The past year has been tumultuous for prices, to say the least – inflation has risen 6% after remaining at all-time lows for most of the past decade. While the Fed has remained steadfast in its earlier this year targets of delaying interest rate hikes until late 2022 / early 2023, current market conditions could force an earlier hand.

The Federal Open Market Committee is expected to widely announce at its meeting tomorrow that it will start reducing its bond buying program.

Government bond yield curves have flattened around the world as central banks are expected to end the era of loose monetary policy put in place at the start of the pandemic, Bloomberg added.

As committee members prepare for their meeting, investors likely wanted to get rid of their positions in anticipation of the official announcement of an earlier-than-expected interest rate hike. Central bank policies that tighten the currency or raise interest rates often lead investors to expect slower economic growth and inflation.

See: Consumer sentiment remains weak, with gains slightly outpaced by the highest inflation rate in “nearly 40 years”
Social security analysis: Why the CPI-E is the “best index to measure inflation” in terms of COLA for seniors

With galloping inflation suffered over the past year, the only remedy might be to raise interest rates. The reason this decision would be so historic is that rarely does a central bank take this step with unemployment issues and unstable overall market conditions. The US economy, although greatly improved from the peaks of the pandemic, has yet to experience its full economic take-off.

More from GOBankingTaux

Last updated: November 2, 2021

This article originally appeared on GOBankingRates.com: The Treasury yield curve has flattened: why it’s bad news for economic growth and inflation

Source link

Comments are closed.