The yield curve is a chart showing yields on bonds of different maturity. The most common example is the Government Bond Yield Curve, but there are many types of yield curves for other types of bonds, such as corporate bonds, high yield bonds, and so on.


The yield on a 3-month US government bond on September 4, 2020, is 0.11, two years is 0.14, five years is 0.3,... Putting those points together we get a yield curve. at the present time also known as the Yield Curve


The yield curve will be different from the yield chart for individual terms, above is a chart of the yield on a US 30-year Government Bond.

Above is a complex definition of the type, simply said it is just a line connecting the yield levels of different maturity bonds. The top example is an example I draw for you to understand, the data I take from the table below. The yield curve is formed when we connect the points representing the yield of US government bonds with the terms of 3 months, 2 years, 5 years, 7 years, and 10 years. The yield curve is often referred to as the standard yield curve.

Yield curve analysis helps us to position the bond markets and their direction, determine their position in relation to the economic cycle, and predict what the next stage is likely to be. Come on.

YIELD CURVE CONSTRUCTION

How to build a yield curve, I showed it above. The vertical axis (vertical axis) of a yield curve chart shows yield, while the horizontal axis shows the maturity of a bond (usually converted to months to get the right rate on the chart). The yield curve itself is the line connecting each of these yields on the chart.

Each day, the U.S. Treasury reports yields for various U.S. government bonds, from 1 month to 30 years. The table below shows the yields with the last updated date of 09/04/2020, which is last week. All these yields are computed annually; For example, when you own a one-month bond, you will receive 0.09% / 12 = 0.0075% for 1 month.


Although the yield curve can be constructed using data for all terms, having too many short-term yields on a curve is usually not very valuable. We only need 1 relative curve, so the yield curve will ignore some short-term yields. The yield curve that we should, and should normally use, will include yields for terms: 3 months, 2 years, 5 years, 7 years, 10 years, 20 years, and 30 years.

EXPLAIN

In general, the yield curve reflects how investors think about risk. Under normal circumstances, one would expect to receive higher compensation (interest) for longer terms. When you lend money to the government for 20 or 30 years, you'll get higher compensation than if you only lent a few months or a year.

The yield curve visually reflects yields for different terms. The shape of a yield curve, as well as its change over time, can help us to identify the current economic climate and signal changes in the economic environment.

YIELD CURVE SHAPE

Basically, there are three shapes that a yield curve can have. 
  • Normal curves have short-term rates lower than long-term rates
  • The curve reverses when short-term rates are higher than long-term rates
  • The Flat Curve has nearly equal short- and long-term rates.
NORMAL CURVE

In a normal yield curve, the yield on short terms is lower than for high terms, yield curve curves up gradually, at a rate of gradual increase in yields. In general, in a normal, debt-free state, thinking it will be simpler, that is the shorter the maturity date, the less risk we are and, therefore, the lower the yield (the premium). for a bond with a longer-term, that is why it produces this curve.

A normally shaped yield curve is normally seen in a normally growing economic environment and there is no change in inflation or available credit.


The chart above shows the yield curve on March 12, 2010, when the economy began to recover from the Great Depression. This curve is quite steep, usually appearing early in the recovery phase. The S&P 500 chart on the right shows that the stock market is beginning to recover from the previous year's lows.

An inverse yield curve refers to a situation in which a bond with shorter-term yields a higher yield than a longer bond. Regardless of the name, the inverse yield curve doesn't necessarily have to be "completely" reversed. Sometimes only parts of the curve are reversed; This can cause lumps like a lump or a dent like a pothole on our curve, which shows an abnormality. You try to imagine as shown above, what will the 5-year bond yield be like, which is greater than 7 years?

An inverse yield curve is often seen as a signal that economic growth will soon slow down or reverse, possibly even signaling the start of a recession. The reason is that investors think that the period of economic growth has, or will soon end, it will turn the short-term risk higher than the long-term risk, so the level of return must also increase commensurate with that level of risk. In addition, it also shows a very high demand for liquidity of the economy in the short term, when issuers accept a high-interest rate to raise short-term capital. This usually happens when the Government implements a monetary tightening policy, which reduces the ability of the economy to access capital. This process can cause a (partial) reversal of the yield curve.

An inverse yield curve is relatively rare; When they do happen, they tend to attract a lot of attention.


The example above shows the reversed yield curve on August 24, 2000, amid the burst of the dot-com bubble. The S&P 500 chart to the right shows that the stock market has begun preparing for a major downturn around this time of the reversal.

When people talk about "the inversion of the yield curve", they usually refer to the 10-year - 2-year segment; The curve is considered inverse when the 10-year yield is lower than the 2-year yield. We can see it appearing on August 24, 2000, in the above yield curve chart.

Another way to show that relationship is to plot the difference between these two yields (UST10Y- UST2Y), as shown in the chart below.


When this relationship falls below zero, the curve 10-2 reverses. The spread chart shows us that the yield curve was reversed for most of 2000, corresponding to the dot-com bubble burst.

FLAT CURVES 

When the yield curve is "flat", the yield will be the same for all terms. This means that you will get roughly the same amount of compensation when you lend money, whether for 2 or 30 years. You are not compensated for a longer loan period while the risk is higher.

When the economy moves from expansion to contraction and the yield curve changes from normal to inversion (or vice versa), it must go through the flat phase first. Consequently, the flat curve can be considered a phase of transition in an economy from one period to another.


The chart above shows a fairly flat yield curve on July 16, 2007, which served as a precursor to the Great Depression. The S&P 500 chart to the right shows the price flattening as the economy moves from recovery to recession.

YIELD CURVE CHANGE

Changes in the shape of the curve over time are measured by the slope of the yield curve. When there is a large difference between the beginning (short term TPCP yield) and the end (long term TPCP yield) of the curve, it is considered a steep curve. When there is little difference between the two ends, the curve is considered flat.

The process of changing the curve from slope to flat is often referred to as the  "flattening" process; Similarly, a change in the curve from flat to steep is referred to as "steepening".

The "flattening" or "climbing" of this curve can help investors signal changes in the economic environment.

FLATTEN

The yield curve is said to be flattened as long-term yields drop while short-term yields go up, which reduces the difference between the two and makes the curve less steep. This flattening usually occurs when the economy is in full recovery mode.

The chart below compares the yield curve on two different dates. The darker red line is the yield curve at the beginning of 2010, while the lighter red line is the curve at the end of 2018. As you can see, the yield on the longer terms falls while the yield on the shorter futures move higher, which causes a very steep curve in 2010 to turn into a very flat curve in 2018. 2010 is the year we are in a state of beginning of recovery, with the path to yields are sloping up in a normal state, the "flattening" process has been going on until 2018, we can say that the economy is in a "full recovery" mode.


CLIMB THE SLOPE

This is the opposite situation when the difference between the ends of the curves is small but starts to increase. A steep curve is often seen at the beginning of a growth or expansion period.


The chart above shows an example of a curve that is climbing. In May 2007 the yield curve was very flat, with yields for all terms hovering around 4.65%. From that point to August 2010 yields began to decline, but they fell more sharply for short terms. This asymmetric decline has caused a meandering curve. The period of 2010 is also associated with the recovery of the economy!

RELATIONSHIP WITH THE ECONOMIC CYCLE

The direction of the curve and the change in the shape of the curve are often used to determine our current position in the economic cycle (sometimes called the business cycle). The table below shows how the yield curve typically works in each segment of the cycle.


The chart above shows the S&P 500 Index on the month frame from the 1970s. The red and green dotted lines mark the start and end dates of the expansion and contraction of the economic cycle definition of NBER (US National Bureau of Economic Research). Therefore, the area from the red line to the green line marks a period of contraction, while the area from green to red marks a period of expansion.

The difference between the 10-year and two-year yields is plotted below the graph. The orange circles show the 10-2 curve below zero, which means the yield curve is reversed. We can see that a yield curve is often reversed before every period of market contraction since the late 1970s. Then we can conclude that the yield curve is often reversed. or flat at the onset of the recession.

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