What is Yield Curve?
A yield curve is the relationship between interest rates and time, and is determined by plotting the yields of bonds with equal credit quality against their maturities.
What does the yield curve tell you?
By looking at the yield curve of bonds with similar credit quality but different maturity dates, the slope of the curve will give you a good idea of future interest rate changes and economic activity.
Yield curves can take the form of three shapes: normal (upward sloping curve), inverted (downward sloping curve), and flat. A normal yield curve continues to increase in yields on long-term bonds, pointing to economic expansion. An inverted yield curve shows that short-term interest rates are higher than long-term interest rates, indicating an economic downturn. When the yield curve is flat, the yield is the same for all maturities, indicating an unpredictable economic situation.
Why is the yield curve important?
It gives an insight into what all investors look for within the economy and can be a Indicators for developing market conditions, The yield curve essentially reflects the opinions of all market participants, so it will give you the best idea of what is really happening with the market.
In addition to helping investors determine how the market is performing, the yield curve also has a great impact on the money supply of an economy. This can affect the ability of individuals and businesses to obtain traditional bank loans. If there is concern about future economic growth (that is, the flattening of the curve), the market is reluctant to require higher rates, which forces banks to lend money at lower rates. As a result, due to lower interest rates, banks have less incentive to lend, as there are risks involved. This negatively affects the economy, as individuals and businesses will not be able to borrow easily.
What is Yield Curve Inversion?
An inverted yield curve slopes downward and can predict an economic downturn. This indicates that long-term debt has lower returns than short-term debt and that shorter-term bonds have higher returns than longer-term bonds.