Negative Yield Curve

Negative yield curve

When the yield on a short-term security is higher than the yield on a long-term security, partially because high interest rates are creating a greater demand for short-term borrowing.

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Inverted Yield Curve

A yield curve in which the long-term yields on bonds are lower than short-term yields. A normal yield curve trends upward because bondholders expect a larger interest rate for a longer investment; however, if a yield curve turns negative, it indicates that the market believes that demand for long-term debt securities is increasing or will increase, which will drive yields downward. Higher demand for bonds usually occurs when investors believe that stock prices will fall. As a result, an inverted yield curve is a highly bearish indicator and indeed is seen as a predictor of a coming recession. An inverted yield curve is the rarest yield curve. It is also called a negative yield curve.

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negative yield curve

An unusual relationship between bond yields and maturity lengths that results when interest rates on long-term bonds are lower than interest rates on short-term bonds. Negative refers to the downward slope of the curve that is drawn to depict this relationship. Also called inverted yield curve. Compare positive yield curve.

What should investors do when short-term rates exceed long-term rates?

By its very existence, a negative yield curve should be viewed as a market consensus or prediction that interest rates are going to fall, because the market in general has commanded a higher yield for short maturity periods than it has required to attract investment dollars for longer maturity periods. A negative yield curve is usually followed by a flattening and then by a positive yield curve. When this happens, yields on short maturities would probably fall substantially. This shift could occur for various reasons. For example, it could happen as a result of the market coming to expect an easing of inflation; then, yields on longer maturities would also be expected to decline. The longer the maturity, the greater the profit potential for a given decline in yields.

Stephanie G. Bigwood, CFP, ChFC, CSA, Assistant Vice President, Lombard Securities, Incorporated, Baltimore, MD

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Negative yield curve. A negative, or inverted, yield curve results when the yield on short-term US Treasury issues is higher than the yield on long-term Treasury bonds.

You create the curve by plotting a graph with yield on the vertical axis and maturity date on the horizontal axis and connecting the dots. When the curve is negative the highest point is to the left.

A positive yield curve -- one that's higher on the right -- results when the yield on long-term bonds is higher than the yield on the short-term bills. A level curve results when the yields are essentially the same.

In most periods, the yield curve is positive because investors demand more for tying up their money for a longer period. But there are times, such as when interest rates seem to be on the upswing, that the pattern is reversed and the yield curve is negative.