Investors should always understand the performance of a country’s economy. Such information plays a critical role in financial planning and avoiding fiscal challenges. For example, it is important to recognize when the United States might experience the next recession to comprehend and manage the anticipated risk. Such insight helps individuals, businesspeople, and the government to plan the available resources and make financial decisions that will shield them and society from the detrimental impact of a downturn. Market measures should be available to communicate impending fiscal challenges. Although no particular and accurate procedure exists to provide such information, some analysts and investors believe that the U.S. yield curve can play a critical role in this end.
The U.S. Government Yield Curve
Economic experts plot the U.S. government bond yields with diverse maturity dates on the same graph to create the yield curve. On the one end, they put the overnight interest rate of the Federal Reserve, while on the other end, the 30-year “long” Treasury bond. Professionals argue that it is cheaper for the government to borrow finances for a single day than a year or a decade; furthermore, 30 years of borrowing is the costliest (Rennison, Wigglesworth, & Stubbington, 2019). Such an approach is partly evident due to the abundance of unexpected events that can occur over an investment period – the longer the duration, the greater the risk. For instance, if inflation happens and affects a bond’s fixed return, investors seek compensation for assuming the risk. Thus, longer-dated Treasury bonds have a higher yield than shorter-dated ones, which tend to adapt to the Fed’s interest rates. Consequently, the yield curve’s shape usually has an upward slope, left to right, over the investment period.
Risk Assessment Using the Curve
Investors can use the U.S. government yield curve to assess the risk investing in Treasury bonds. They should analyze the graph since it indicates a lot regarding the performance of bonds in the market and the U.S. economy in general. The chart includes important insight into the current and future economic reality. Thus, the curve might indicate the potential benefits and risks of investing with the government at a particular time. The curve’s shape shows how the economy is performing (Rennison et al., 2019). For instance, if it is a steep upward curve, the difference between long- and short-term Treasury yields is big. Hence, investors should expect inflation. The performance determines the level of risk involved in trading with the bonds.
Implications of the Current Shape of the Curve
The current shape of the U.S. yield curve shows some concerns about the country’s economic performance. The entry into the negative territory of the spread between the short and long end in March 2019 creates apprehension regarding a potential recession. A yield curve inversion for the last six decades preceded an economic downturn. Therefore, the current change should not be an exception. Although some economists argue that the present change might differ from the previous ones, statistical analysis reveals a 43-60% recession probability (Carrera, 2019). However, the timing of the economic recession and recovery remains unclear.
Economists and investors rely on financial information to understand the performance of Treasury boards in the market. The U.S. government yield curve provides an accurate assessment of the economic reality and is useful in risk assessment and decision-making regarding investment in bonds. The current shape of the curve indicates the possibility of an economic recession. The insight is critical for investors to decide on the security of their investments.
Carrera, J.B. (2019). The shape of the U.S. yield curve: A cautionary tale. Retrieved from https://www.eulerhermes.com/en_global/economic-research/insights/The-shape-of-the-US-yield-curve-a-cautionary-tale.html
Rennison, J., Wigglesworth, R., & Stubbington, T. (2019). What is the US yield curve and why has it spooked investors? Financial Times. Retrieved from https://www.ft.com/content/bce006d2-f8e2-11e8-8b7c-6fa24bd5409c