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What Do Different Yield Curve Shapes Mean

The yield curve plots the yields of bonds with different maturities but the same credit quality, showing investors' expectations for future interest rates and economic growth. A normal yield curve slopes upward as longer-term bonds have higher yields, reflecting higher risk. An inverted curve slopes downward and indicates expectations of future rate cuts, often preceding recessions. A steep curve means investors demand higher yields for long-term bonds, expecting quick economic improvement. A flat curve signals uncertainty around future growth. The curve provides an early warning of recessions but cannot gauge one economy versus another or be used alone.

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181 views

What Do Different Yield Curve Shapes Mean

The yield curve plots the yields of bonds with different maturities but the same credit quality, showing investors' expectations for future interest rates and economic growth. A normal yield curve slopes upward as longer-term bonds have higher yields, reflecting higher risk. An inverted curve slopes downward and indicates expectations of future rate cuts, often preceding recessions. A steep curve means investors demand higher yields for long-term bonds, expecting quick economic improvement. A flat curve signals uncertainty around future growth. The curve provides an early warning of recessions but cannot gauge one economy versus another or be used alone.

Uploaded by

Hihihi Hohohoho
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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FOR INFORMATION PURPOSES ONLY

What do different yield curve shapes mean?


Bonds are issued with different maturities, ranging from the very short term (less than a year) to the very long term (up to 30 years). Bonds of different maturities but the same credit quality, issued by a
single issuer, will have different yields, reflecting the perceived risk of investing in them. In general, the longer the maturity of the bond, the higher the risk to the investor, and so the higher the yield.
The yields of bonds of equal credit quality but different maturities can be plotted and joined up into a curve. Investors often use the yield curve of a country’s government bonds to tell them how the
economy of that country is expected to behave.

% % % %

Maturity Maturity Maturity Maturity

NORMAL INVERTED STEEP FL AT


The market expects the economy to function The market expects the economy to slow down Long-term bond holders expect the economy The market is at the point of inflection, preceding
at normal rate of growth: and interest rates to drop in the future. to improve quickly in the future. either a recession or an economic pick-up.
No significant changes in inflation or available Long term investors want to take the opportunity Long-term investors fear being locked into
capital. So, investors who risk their money for to lock in interest rates before they fall even further. low interest rates so therefore demand greater
longer periods expect higher yields. compensation more quickly than the more liquid
short-term rate holders.

e.g. Dec 1984 – middle of longest postwar expansion e.g. Recession in the early 1980’s. Has become permanent e.g. Apr 1992 – spread between long and short term e.g. Nov 1989 – the curve flattened. The economy was
in the US; GDP growth rates at a steady 2-5%. in UK due to excess demand from pension funds. treasuries was 5bps. The economy followed, with GDP in recession by 1991.
rising 3% in 1993.

Interpreting the yield curve


The yield curve is often viewed as a leading indicator, providing an early warning on the likely direction of a country’s economy – for example, the yield curve has historically become inverted 12-18 months before a recession.
This is because the slope and shape of the curve reflects investors’ expectations about future interest rates, and, by extension, about economic growth.
It’s important to remember, though, that there are limitations on what can be gleaned from looking at the yield curve. Yield curves reflect not only interest rate expectations, but investors’ attitude to risk and their need
for different maturities of bond. In the UK, for example, demand from pension funds for long-dated bonds to match their liabilities means the yield curve has become permanently inverted.
Comparing the yield curves of two different government bond markets is therefore not a reliable way to gauge the potential performance of one economy versus another – particularly when used on its own. But knowing
what’s normal for the markets in which you invest can help to make the yield curve a more useful tool.

FOR INFORMATION PURPOSES ONLY


This document has been produced for illustrative purpose only and as such the views contained herein are not to be taken as an advice or recommendation to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader and ratings should not form the sole basis of an
investment decision. This material does not contain sufficient information to support an investment decision and investors should ensure that they obtain all available relevant information before making any investment. The value of investments and the income from them can fall as well as rise and investors may not get back the full amount
invested. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co and its affiliates worldwide. Issued in the UK by JPMorgan Asset Management (UK) Limited which is authorised and regulated by the Financial Conduct Authority. Registered in England No. 01161446. Registered address:
25 Bank St, Canary Wharf, London E14 5JP, United Kingdom. 4d03c02a80031d04 LV–JPM30252 | 03/16

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