Definition
The financial investing term inverted yield curve refers to a downward sloping line plot used to illustrate the interest rate differences between short and long-term debt instruments. An inverted yield curve is a rare event, since it indicates short-term rates are higher than longer-term rates. When debt securities issued by the U.S. Treasury Department result in an inverted curve, it's deemed a signal the economy is about to enter a recession.
Explanation
Also known as the term structure of interest rates, yield curves are typically used depict the relationship between interest rates and the time to maturity of a debt security such as a bond. The shape of the curve provides the analyst-investor with insights into the future expectations for interest rates, as well as possible increases or decreases in macroeconomic activity. Yield curves are simple line plots showing the term, or maturity, on the x-axis (horizontal axis) and the corresponding rate of interest, or yield, on the y-axis (vertical axis). When plotting a yield curve, the securities should be of similar, if not identical, credit quality.
A yield curve can take on several different forms, and as the illustration below demonstrates, an inverted yield curve has a negative slope that is asymmetrical; the returns on longer term maturities decline at a progressively slower rate. Yields that result in inverted curves are rare, since they indicate short term interest rates are higher than long term rates. When a plot of debt issued by the U.S. Treasury Department results in this type of curve, it's typically interpreted as a signal the United States is about to enter a decline in economic activity, inflationary times, or a recession. The term partial inversion is used to describe situations where some short term securities have higher yields than longer term bonds.
There are a couple of explanations for this type of curve:
Long-Term Interest Rates: investors believe interest rates will be lower in the future, resulting in a sharp increase in demand for longer-term bonds, which subsequently lowers yields.
Short-Term Credit: borrowers believe interest rates will be lower in the future, thereby driving up the demand for short-term credit. This sharp increase in demand for short-term credit results in an increase in near-term interest rates.
Example
The following illustration demonstrates the shape of a normal versus inverted yield curve.
Related Terms
- The financial investing term yield curve refers to a line plot showing the term, or maturity, on the x-axis and the corresponding rate of interest, or yield, on the y-axis. Yield curves are oftentimes used to compare interest rates on bonds such as debt securities issued by the U.S. Treasury Department, which have maturities that range from one month to thirty years.
Moneyzine EditorNovember 6th, 2024 - The financial investing term normal yield curve refers to an upward sloping line plot used to illustrate the interest rate differences between short and long-term debt instruments. Debt securities issued by the U.S. Treasury Department typically exhibit a normal yield curve, whereby the interest rates paid on securities with shorter maturities is lower than rates paid on debt with longer maturities.Moneyzine EditorSeptember 20th, 2023
- The financial investing term steep yield curve refers to a rapidly upward sloping line plot used to illustrate the difference between short and long-term debt instruments at various maturities. A steep yield curve is a variation of the normal yield curve, possessing the same basic properties; whereby the interest rates paid on securities with shorter maturities is lower than rates paid on debt with longer maturities.Moneyzine EditorSeptember 21st, 2023
The financial investing term flattened yield curve refers to a line plot that runs parallel to the x-axis, indicating rates that do not vary with maturity. A flattened yield curve is a very rare event; since it indicates both short and long-term debt provide the investor with the same return. A flattened curve for debt securities, such as those issued by the U.S. Treasury Department, can occur as yields shift between normal and inverted.Moneyzine EditorNovember 6th, 2024
The financial investing term humped yield curve refers to a bell-shaped curve, indicating mid-term rates that exceed both long and short term rates. When debt of similar credit quality, such as that issued by the U.S. Treasury Department, result in a humped yield curve it's typically interpreted as a slowing of the economy.Moneyzine EditorSeptember 20th, 2023
The financial investing term backwardation refers to a market condition where the current price of a futures contract is lower than the anticipated spot price at maturity. Backwardation is considered an unusual market condition; the normal form of this relationship is known as contango.Moneyzine EditorNovember 6th, 2024
The financial investing term contango refers to a market condition where the current price of a futures contract is higher than the anticipated spot price at maturity. Contango is considered a normal market condition, while an unusual form of this relationship is known as backwardation.Moneyzine EditorNovember 6th, 2024
