Do Bond Investors Know Something Others Don’t

Do Bond Investors Know Something Others Don’t

Key words and Definitions

  • Yield curve – the graphical representation of the term structure of interest rates.
  • Normal yield curve – a normal yield curve is upward sloping to the right indicating that yields are higher for longer term securities.
  • Inverted yield curve – an inverted yield curve is downward sloping to the right indicating that yields are lower for longer term securities.

Summary: Key Points in the Article

While the stock market appears to be shaking off the losses suffered when Russia invaded Ukraine it appears bond investors are not as optimistic. Yields on short-term U.S. Treasuries rose above longer term U.S. Treasuries for the “first time since September 2019.” This inversion of the yield curve rarely occurs and often signals a recession.

An inverted yield curve has preceded every U.S. recession since 1955. And, the metric has only produced one “false positive” signal over that time span. So, the recent inversion coupled with a rising stock market begs the question, “Do bond investors see something that other investors are missing?”

One expert attributes the differences to lags. Research has shown that the stock market typically peaks about a year after the yield curve inversion. However, other experts caution everyone about reading too much into the brief inversion given that it could merely signal that the Fed will need to get tough in the short-term and aggressively raise interest rates to combat the current high inflation.

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Thinking Critically Questions:

  • Why do investors get concerned when the yield curve is inverted?
  • What factors are pushing short-term yields higher than long-term yields?
  • What is the relationship between bond yields and bond prices?
  • What are the risks involved with bond investing?

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