The shape of the yield curve is a signal that the market is expecting good news or bad news. Before we can explore what the shape of the yield curve means for financial markets, let's define the "yield curve."
First, the term structure of interest rates: from Investopedia:
The term structure of interest rates is the relationship between interest rates or bond yields and different terms or maturities. The term structure of interest rates is also known as a yield curve, and it plays a central role in an economy. The term structure reflects expectations of market participants about future changes in interest rates and their assessment of monetary policy conditions.
Read more here: Term Structure Of Interest Rates
In other words, the term structure of interest rates is a table that lists the various terms, or maturities, of bonds and their corresponding yields to maturity or YTMs. When we convert this table into a graph, we get the "yield curve."
So the term structure is a table and the yield curve is the picture of that table.
The question then is this: what does the shape of the yield curve tell us?
Most of the time, the shape is upward sloping or "normal." That is, most of the time, investors require higher yields on longer term debt than they do on shorter term debt. But every now and then, investors value the short term so much that the yields on short term debt are driven higher than long term debt. At times like these, we say that the yield curve has inverted.
The video below explains what a flattening yield curve implies about the economy. In this case, the curve hasn't inverted yet, but is heading in that direction.
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