What is an Inverted Yield Curve?
We wanted to talk about two things today. One, what is an inverted yield curve? Two, why does it matter? An inverted yield curve is when the short end of the curve, the three-month treasury or CD rates, are higher than the long end, the 2-year, 5-year, and 10-year treasury rates. A normal curve is described as the longer you lend someone money the more interest they must pay you.
Why does it matter?
The yield curve matters because it’s an indicator of economic growth and health. So, if the long-term expectations of economic growth are low then it causes long-term interest rates to go down. If you can get more interest on the short end, then why would investors lend on the long end? So, it makes it harder for companies or individuals looking to borrow for things such as mortgages because investors are more willing to give money on the short end rather than long end. For example, as of Monday (12/10/18) the 3-month treasury rate is sitting at 2.4%, the 2-year is at 2.72%, the 5-year is at 2.7% and the 10-year is at 2.85%. The 2-year is a bit higher than the 5-year so while the long end isn’t quite inverted yet, we are getting close. With the Federal Reserve likely to raise rates in December, that could force the short end to become higher and create an inverted yield curve which has proved to be detrimental, historically, to economic growth. That’s why we are watching it closely and why the markets are focusing on it so much and again, historically speaking, it proves that long-term economic growth could be slower.
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