There are very different investment instruments, but it is necessary to understand the moments and factors that influence an operation of this type of investment and to do it successfully. Learning how to invest on the yield curve chart can help you understand the signals that anticipate a recession or future economic growth.
According to Olav Dirkmaat, Dutch professor of economics and co-director of the UFM Market Trends financial analysis agency, if we look at the history, we would be in a recession in the next 6 to 9 months.
The economist believes that not only could there be a recession, but also a fall in the US stock market.
Dirkmaat came to this conclusion by looking at the yield curve. This is considered in the world of the economy as the powerful thermometer that anticipates the next recession in the United States, a situation that would affect the rest of the world, especially today that markets are more connected than ever.
And what is the yield curve chart?
In the most literal sense, it is a graphic representation that shows the relationship between performance and the maturity of public securities or bonds.
Countries usually issue debt through a bond or other securities to finance themselves. They borrow money offering a certain return to investors.
The yield curve chart shows precisely the effect of fiscal and monetary policy.
If you review the last 10 or 15 years, you will notice the recessions that occurred when the yield curve was reversed. Therefore, it is considered the thermometer of a country’s future economic growth.
Even when reviewing the post-World War II era, the yield curve appears as inverted before each recession.
Generally, it is the steepest after the recessions, as the Federal Reserve of the United States (Fed) lowers the rate of federal funds to stimulate economic activity and flattens as the rate of federal funds increases to contain inflation.
It is then that the Fed raises interest rates in the short term. When a recession comes, the curve is reversed because the two-year yields are higher than the 10-year yields.
The yield curve chart that is formed by the performance-term relationship can present different behaviors:
- Upward curve: Follow the logic of “long term investment, higher yield” because investing in longer terms implies more uncertainty. At the same time, it could be interpreted that the next economic activity has an acceleration perspective.
- Descending Curve: Represents lower future yields than current ones. A deceleration in future economic activity can be predicted.
Bonuses above the curve are a good investment opportunity because, in the same term, they will have higher returns. The opposite case occurs when the bonds are below the curve.
We could say then that this curve represents the difference between short-term interest rates and long-term interest rates. In the financial market, it specifically refers to the interest rates of government bonds, that is, the debt issued by a country. It is customary to compare a bond with a maturity of two years, which is a short term, with one to 10, 20 or 30 years, which is a long term.
If an economy is booming, then the curve increases reflecting that short-term rates are lower than long-term rates. When it happens the other way around, that short-term interest rates are higher and the curve begins to flatten, as has been happening in the United States, it could be worrisome.
Then, if the curve is reversed, the economy may be in trouble.
For Dirkmaat it is the most important indicator of crisis.
The key “messages” of the performance curve
- Although it flattened for much of 2017, when margins between long and short maturities were recently reduced to lows, the yield curve of the US Treasury has begun to increase.
- Historically, investors have considered the shape of the yield curve as a sign of future growth. In mid-2018, the curve suggested continued economic expansion.
In conclusion, the yield curve chart is a valuable indicator of the real-time economic cycle and can be improved by incorporating the changing level of interest rates into the analysis. In this way, investors have the opportunity to identify sectors and sub-sectors that are more likely to outperform the market in general.
It is important, therefore, that if you are an investor with little experience and want to be more certain when using your money, look for the support of the experts in the subject to take advantage of this tool and obtain better results.