Benjamin Wey is a journalist and a Wall Street financier. A graduate of Columbia University, Benjamin Wey is a senior adviser to several government entities and businesses. Benjamin Wey is also the CEO of New York Global Group (NYGG) Mr. Wey shares his thoughts about economic theories:
You may have heard or read the financial wizards in the media (or, more likely, the people who like to repeat what they say in order to sound smart) discussing the flat yield curve. Your response was probably nonexistent or at most “Hmm. Well, I have a lot of work to do so I’ll talk to you later, Steve.” But the recent activity of the yield curve certainly has the potential to impact you directly, even if you have no idea what it is. So here’s the lowdown on the yield curve and all this talk of flatness and inversion. Just don’t let Steve know you know what he’s talking about or it might encourage him.
What Is a Bond?
To understand the yield curve, you must first understand the bond. A bond is an investment in which money is loaned to a corporation or government for a set period of time and at a fixed interest rate.
For example, you can buy a $100 U.S. savings bond for, let’s say, $75, and in 10 years it will be worth the face value of $100 (NOTE: these amounts are completely arbitrary). When you or your grandma bought that bond, you were providing the U.S. government with a loan in order to profit from the interest, just like a bank to a homeowner with a mortgage. This is the principle behind all bonds. These bonds are given ratings by outside agencies based on how reliable the debtor is, from AAA (the best) to CCC (the worst).
The U.S. Treasury offers a wide variety of securities called Treasury bills, notes, bonds, FRNs, TIPs, and, of course, U.S. Savings Bonds. These have varying maturity dates from three months to 30 years. Conventionally, the shorter the maturity date, the lower the interest rate, and therefore, the less money can be made in interest. It only makes sense that you would have a higher rate for 30 years than three months, right?
What Is the Yield Curve?
In general, a yield curve is the line on the chart that tracks the interest rates of bonds with similar ratings but different maturity dates. But usually when Americans mention the yield curve, they are referring to that of U.S. Treasury debt. The yield curve can be classified three ways:
Note that interest rates (yield) for short-term bonds are lower than the interest rates for longer-term bonds (i.e., making more on a 30-year security than a three-week security).
This indicates that investors expect interest rates to rise in the future, making long-term investments more lucrative.
Note that the interest rates for short-term and long-term bonds are the same. This is an example of a perfectly flat yield curve. In reality, the yield curve will just tend toward this shape, not be perfectly flat with uniform yields.
This indicates that investors don’t expect interest rates to rise or fall substantially.
Note that interest rates for short-term securities are higher than interest rates for longer-term securities.
This indicates that investors expect interest rates to fall, so short-term bonds are better investments.
What Does the Yield Curve Mean to You?
Even aside from investors in U.S. Treasury securities, the yield curve has the potential to affect the average citizen. This is because it is an indicator of many things including economic conditions as a whole.
The main reason the inverting or “flat” yield curve is making news right now is because it can be a good indicator of a coming recession. It hasn’t been this flat since 2009. But many experts do not think this is necessarily a sign of the next Great Depression. After all, in 2009, we were coming out of a recession, not going into one. But “recession” is a dirty/scary word to a lot of people, and for good reason. And the news, even the financial news, is in it for the ratings. I wouldn’t necessarily call it sensationalized, but I might compare it to the local weather giving constant updates on a possible severe storm that ends up being a light mist.
If I, Benjamin Wey, were to draw a final conclusion, the yield curve should be followed by those with, or considering, adjustable rate mortgages because the yield curve could tell them something about the interest rates they can expect.
But remember: the yield curve is only a prediction and is not set in stone. Don’t take it as gospel, but certainly don’t ignore it. Just add it as another tool to your toolbox. Get enough tools together and learn how to use them and you might be able to build something nice.