Investopedia: What is an 'Inverted Yield Curve'?

Investopedia
Inverted Yield Curve
Share
What is an 'Inverted Yield Curve'

An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.

.Graph of an inverted yield curve.
Next Up

    Yield Curve
    Term Structure Of Interest Rates
    Yield Elbow
    Humped Yield Curve

VIDEO
Loading the player...
BREAKING DOWN 'Inverted Yield Curve'

A partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have higher yields than 30-year Treasuries. An inverted yield curve is sometimes referred to as a negative yield curve.

Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed. An inverse yield curve predicts lower interest rates in the future as longer-term bonds are being demanded, sending the yields down.
Yield and Maturity

Yields are normally higher on fixed-income securities with longer maturity dates. Higher yields on longer-term securities are a result of maturity risk premium because changes in the value of longer-term securities are more unpredictable with market interest rates potentially more unsettled over a longer time horizon. However, yields on longer-term securities could be trending down sometimes when market interest rates are set to get lower for a foreseeable future to accommodate ongoing weak economic activities. Irrespective of their reinvestment rate risk, shorter-term securities appear to offer higher returns than longer-term securities during such times.
Yield and the Economy

The shape of the yield curve changes in accordance with the state of the economy. The normal or up-sloped yield curve may persist when the economy is growing and conversely, the inverted or down-sloped yield curve is likely to press on when the economy is in a recession. One underlying reason such a relationship exists between the yield curve and economic performance relates to how a higher or lower level of long-term capital investments may help stimulate or rein in the economy. By issuing longer-term securities with lower-yield offerings, businesses and governments alike can acquire needed investment capital at affordable costs to jumpstart a weak economy.
Yield and Bond Demand

What moves yields in the market is the varying demands for securities of different maturities at a particular time and under given economic conditions. When the economy is heading to a recession, knowing interest rates are to trend lower, investors are more willing to invest in longer-term securities immediately to lock in current higher yields. This, in turn, increases the demand for longer-term securities, boosting their prices and further lowering their yields. Meanwhile, few investors want to invest in shorter-term securities when presented with lower reinvestment rates. With lower demand for shorter-term securities, their yields actually go up, giving rise to an inverted yield curve when yields on longer-term securities have come down at the same time.
RELATED TERMS

    Yield Curve
    A yield curve is a line that plots the interest rates, at a set ...
    Term Structure Of Interest Rates
    The term structure of interest rates is the relationship between ...
    Yield Elbow
    The point on the yield curve indicating the year in which the ...
    Humped Yield Curve
    A humped yield curve is a relatively rare type of yield curve ...
    Riding the Yield Curve
    Riding the Yield Curve is a trading strategy that involves buying ...
    Positive Butterfly
    A positive butterfly is a non-parallel yield curve shift in which ...

Related Articles

    Investing
    The impact of an inverted yield curve
    Understand how the relationship between short- and long-term interest rates contributes to an inverted yield curve – a noteworthy economic event.
    Insights
    U.S. Recession Without a Yield Curve Warning?
    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
    Investing
    One Thing The Yield Curve Says About Stocks
    Contrary to media hype, a flattening yield curve does not mean a recession is coming soon.
    Investing
    Interest Rates and Your Bond Investments
    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
    Investing
    Charles Schwab: Large-Cap Stocks Could Restart Their Outperformance
    Owing to a flattening of the yield curve, Charles Schwab said that large-cap stocks could outperform again.
    Insights
    Four Scenarios: Fed Policy, the Yield Curve and Recessions
    If you were to compile a list of the most effective recession predictors, the term spread, or difference between short and long-term interest rates, would likely be at the top of that list.
    Insights
    Why the 10-Year U.S. Treasury Yield Matters
    10-year treasury bond yields are important indicators of the economy as a whole.
    Investing
    How Bond Market Pricing Works
    Want to know how bond price are determined? Learn the basic rule of the bond market.
    Insights
    Bank Stocks Set to Shine as Fed Tapering Begins
    As the Fed embarks on a monumental shift in policy, Goldman Sachs sees value in financials.
    Investing
    Why Surging Bond Yields Won’t Kill the Bull Market
    Yields are rising for all the right reasons and that is a positive for earnings and stock prices.

RELATED FAQS

    What is the difference between term structure and a yield curve?
    Understand the difference between the term structure of interest rates and a yield curve, if any. Learn what the yield curve ... Read Answer >>
    How can I create a yield curve in Excel?
    Understand how a yield curve depicts the term structures of interest rates,, discover how to measure U.S. Treasury bonds ... Read Answer >>
    What is the difference between yield and rate of return?
    Read about the differences between yield and rate of return. See why many novice investors often struggle more with the concept ... Read Answer >>
    Which economic factors impact treasury yields?
    Discover the economic factors that impact Treasury yields. Treasury yields are the benchmark yield for the rest of the world, ... Read Answer >>
    What is the difference between yield to maturity and the yield to call?
    Determining various the various yields that callable bonds can provide investors is an important factor in the bond purchasing ... Read Answer >>

Trending

    The Dummies' Guide To The Iran Nuclear Deal
    What You Should Know About Net Neutrality
    A Stock Sell-Off Vocabulary Guide
    Understanding Interest Rates, Inflation And Bonds
    Everything You Need To Know About Earnings

Hot Definitions

    Inverted Yield Curve
    Debt Ratio
    Dividend Yield
    Porter's 5 Forces
    Monetary Policy
    Gross Profit Margin

    Work With Investopedia
    About Us Advertise With Us Contact Us Careers

© 2018, Investopedia, LLC. All Rights Reserved Terms Of Use Privacy Policy