Explain like I’m 5: Yield Curve Inversion

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Usually when you go and try to get a CD from a bank, they offer you more interest for the longer you let them keep your money. BUT what if you got more interest for giving them your money for say 6 months versus 6 years? That’s inversion. Short term yields are greater than longterm yields.


Your basically picking the fruit today because you don’t think the tree is going to produce fruit tomorrow.?


Currently, you gain less yield for a 10 year bond vs a 2-year bond. Initially, this doesn’t make much sense. Holding up your money for a longer time period should produce a higher yield. The only reason this is the case is that investors are so unconfident in the state of the economy in the next 2 years, they would rather keep their money safe and guaranteed for 10 years. It is unlikely the economy will still be in turmoil 10 years from now. Bond prices and yields go in opposite directions. The more expensive a bond is, the lower the yield. So lots of people are buying 10-year bonds and less are buying 2-year bonds.


The yield curve is a plot of the yield of treasury bonds vs duration. Normally the curve slopes upwards with longer term bonds having a higher yield than shorter term bonds. Sometimes the curve flattens and then inverts with shorter term bonds having a higher yield than longer term bonds. It indicates that the market thinks monetary policy is too tight and rates are expected to fall in the future. In the past, in the US at least, an inversion in the yield curve has usually preceded a recession with about half a year to two years lag. Often people look at the 2yr-10yr spread in yields which just inverted but the 3mo-10yr spread has already been inverted for a while.


Banks borrow money at the short term rates and lend at long term rates. If long term rates > short term rates, bank make profits and lend more money. (Good for economy) If long term rates < short term rates, banks have difficulty earning profits; therefore they lend less (bad for economy)