Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “Yield Curve”
Shorthand for comparisons of the interest rate on government bonds of different maturity. If investors think it is riskier to buy a bond with 15 years until it matures than a bond with five years of life, they will demand a higher interest rate or yield on the longer-dated bond. If so, the yield curve will slope upwards from left the shorter maturities to right. It is normal for the yield curve to be positive upward sloping, left to right simply because investors normally demand compensation for the added risk of holding longer-term securities. Historically, a downward-sloping or inverted yield curve has been an indicator of recession on the horizon, or, at least, that investors expect the central bank to cut short-term interest rates in the near future. A flat yield curve means that investors are indifferent to maturity risk, but this is unusual. When the yield curve as a whole move higher, it means that investors are more worried that inflation will rise for the foreseeable future and therefore that higher interest rates will be needed. When the whole curve moves lower, it means that investors have a rosier inflationary outlook.
Even if the direction of a yield curve is unchanged, useful information can be gleaned from changes in the spreads between yields on bonds of different maturities and on different sorts of bonds with the same maturity such as government bonds versus corporate bonds, or thinly traded bonds versus highly liquid bonds.
By Barry Norman, Investors Trading Academy - ITA