The Yield Curve And Its Relevance To The Stockmarket

CFD traders will often hear the phrase ‘yield curve’ used in long and short term evaluation of investment trends, and it is seen as important as one barometer for the outlook for the economy, and thus the stockmarket. The curve itself shows the structure of interest rates plotted over different maturities as measured by government bond prices, from the shortest dated bonds, which usually are related to short term interest rates, to long-dated i.e. 30 year plus maturities.

This enables investors firstly to be able to compare the yields offered by short-term, medium-term and long-term bonds. As there is usually a higher risk involved in choosing a longer dated maturity, typically the yield curve should slop upward, but it is the actual slope that is of interest. This also has relevance for forex investors as it reflects one part of longer term currency risk evaluation.

The three shapes of the curve

The yield curve usually takes one of three shapes. If short-term yields are lower than long-term yields, the line of interest rates will slope upwards, online borsa guida and this is seen as normal.

If short-term yields are higher than long-term yields, the line then slopes down (at least at the beginning), and this is referred to as an inverted or negative yield curve.

Occasionally, a flat yield curve reflects hardly any disparity between short-dated and long-dated yields.

What bonds are plotted?

It is very important that only bonds of similar risk are plotted on the curve, as the gap between low and high risk bonds itself is another factor for longer term investors to examine when choosing investments. In the US, the most common type of yield curve plots Treasury securities because they are considered risk-free and are used as a benchmark for determining the yield on other types of higher risk debt. The yield curves are calculated and published by The Wall Street Journal, the Federal Reserve, and a variety of other financial institutions.

In the UK, gilt stocks are used in the same way and it is simple to compile current yield curves from the Financial Times.

The importance of the yield curve

As mentioned above, when the yield curve is positive or sloping upwards, this indicates that investors require a higher rate of return for the added risk of lending money for longer periods of time, which is normal.

If the yield curve shows a steep upwards slope, this indicates to some commentators that investors are looking at strong future economic growth and potentially higher future inflation, which might lead to higher interest rates.

Changes in the shape of the yield curve can also have an impact on portfolio returns by making differently dated bonds more or less valuable relative to other bonds, so analysts and investors need to study yield curves carefully.

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