What’s going on with interest rates... and why should I care? Part Two: The inverted yield curve
Source: Isaac Smith
In my last post, I discussed how the Federal Reserve lowered interest rates for the first time in ten years. Since then, the Fed lowered rates once again. There’s a lot going on with interest rates lately.
Today, we’ll take a look at all the talk around the inversion of the yield curve which took place last month. What does this all mean and why should you care? I’ll break it all down and discuss how it impacts YOUR finances.
The Inverted Yield Curve
What’s a yield curve? Think of the yield curve as all of the government bonds plotted out on a graph according to their maturity (time until you get your original investment back) and their corresponding yield (how much you earn/ cash flow received on your investment).
And now for a short graphing lesson (I promise it won’t take long).
The process of plotting the yield curve goes like this, the terms/maturities are written along the bottom of the graph. So, the 1 month, 3, month, all the way out to the 30 year Government bonds are plotted out on the bottom (x-axis) and their corresponding yields are plotted above (y-axis). A line is then drawn to connect all of the dots.
Source: EIP Trading
Normally, the further you go to the right on the graph, the longer the term of your bond and the more it pays. If you think about it, it makes sense, the Government should pay you more money if they are going to lock up your investment for 10 years vs. 2 years. In a normal interest rate environment, we have a nice graph with a line sloping up towards the right.
Why should you care?
Well, the exact opposite of normal occurred last month and it’s called the inverted yield curve. When plotting out all of the government bonds on a graph according to their maturity and corresponding yield we find the short-term rates are actually higher than the long-term rates. It makes our curve look funny and slope down to the right. Okay, graphing lesson over! Phew!
Source: The Wire
Bizzare, right? So when the yield curve inverts you can actually make more money investing your dollars for 2 years with the Government than for 10 years.
The other interesting piece of information is that mortgage rates are closely tied to the 10-year Treasury note. So if you are looking to borrow, its an opportune time.
So what’s all the hype about?
Well, the yield curve is said to be a predictor of a recession. In fact, eight out of the last 9 recessions occurred after the yield curve inverted. According to Credit Suisse on average, the yield curve inverted and a recession happened 22 months later.
So is it time to run for the hills? Absolutely not! Does this mean a recession will happen in 2021? Who knows! Remember recessions are part of the normal business cycle, meaning there is always another one coming. There are, however, some steps you can take now to get ready for the inevitable. Learn more about what you can do to prepare for a recession in my next blog article.
Interested in learning more? Read more about my firm, and check out my service options.
Christine Centeno, CFPⓇ, MS is the founder of Simplicity Wealth Management. She has over 11 years of industry experience as a financial advisor and is a member of several professional organizations including NAPFA, FPA, and the XY Planning Network. She also holds her Masters in Financial Planning. In 2019, after years of working for large firms, she founded her own firm. Simplicity Wealth Management provides clarity to the complicated nature of financial planning and investing by delivering comprehensive advice without hidden fees and unnecessary jargon that leaves you in the dark. The goal is to deliver transparent, easy-to-understand guidance to help clients achieve their financial goals and remain informed every step of the way.
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