US Inflation Hit a Record High Of 9.1% In June 2022:
US Inflation hit a record high of 9.1% in June 2022, the highest in 40 years.
- US observers have argued that the US central bank will not be able to achieve a soft landing for the economy if the yield curve inverts.
- Start of reverse currency wars has also been predicted.
- Bonds are essentially an instrument through which governments (and also corporations) raise money from people.
- A bond’s yield is the return to an investor from the bond’s coupon (interest) payments.
- Typically, government bond yields are a good way to understand the risk-free interest rate in that economy.
- The yield curve is the graphical representation of yields from bonds (with an equal credit rating) over different time horizons.
- In other words, if one was to take the US government bonds of different tenures and plot them according to the yields they provide, one would get the yield curve.
Bond Yield Inversion:
Under Normal Circumstances:
- Any economy would have an upward sloping yield curve.
- As one lends for a longer duration — or as one buys bonds of longer tenure — one gets higher yields.
- If one is parting with money for a longer duration, the return should be higher.
- When investors feel confident about the economy they pull the money out from long-term bonds and put it in short-term riskier assets such as stock markets.
- In the bond market, the prices of long-term bonds fall, and their yield (effective interest rate) rises.
- This happens because bond prices and bond yields are inversely related.
Suspicious Circumstances:
- However, when investors suspect that the economy is heading for trouble, they pull out money from short-term risky assets (such as stock markets) and put them in long-term bonds.
- This causes the prices of the long-term bonds to rise and their yields to fall.
