Thread by @MFkiRani

#US #InvertedYieldCurve & panic
On wed, #DowJones, #nasdaq & #SP500 saw more than 3% fall, highest in year so far
Reason? #10YearTreasuryYield < #2YearTreasuryYield, #spread being 0.04%, lowest since 2007
- Treasury notes are #USGovernment securities issued for 2, 3, 5 & 10 year

Starting with basics first.
1. #InterestRate & #BondPrices have #InverseRelationship, meaning if interest rises bond prices fall & vice versa

Why? eg. if currently #Coupon rate on a bond is 6% & int rate is also 6% & face value of bond is rs. 100. Meaning buyer of bond is willing to pay more or less complete face value of rs. 100

If #InterestRate rise to 8%, this existing bond will become unattractive since it is giving coupon of only 6% & new bonds will be issued equal or above prevailing interest rate & buyers will be more interested in that.

So your existing #bond price will fall below rs.100 coz less demand because of less demand for it. If interest fall opposite will be true.
Note - #facevalue or par value is more or less the value you will receive if you keep the bond till #Maturity.

Current Bond price is determined by #demand and #supply based on many factors, interest rate being a prominent one.

2. What is #BondYield?
bond yield is the return you get on the price of the bond, expressed in annual percentage terms. For eg, you are getting interest of rs. 10 annually and you paid rs. 110 for it , so your current yield will be (10*100) /110 = 9.09%

Note - coupon rate on a bond and bond yield are NOT THE SAME.

#Coupon is interest promised on the bond, is more or less fixed in nature and is calculated on face or par value. If coupon rate is 6% , face value is rs. 100, every year investor will get rs. 6 as interest.

yield is calculated on the current price of bond which may be trading at a discount or premium to the face value after it is issued based on many factors.

Suppose current price of bond is rs. 110 ,ie trading at premium, coupon he will get is rs. 6 ever year ( stated above and is fixed), then current yield is = (6*100) /110 = 5.45%

What is a yield curve?
Simply a graph representing bond maturity on x- axis and current yields corresponding to maturity on y-axis. Similar to the one below.

A normal yield is upward sloping or ascending simply because #investors expect more #returns for #investing in a longer tenure, similar to like in a #bank #deposits, where interest rate you get on a 2 year fd is less than interest rate you will get on a 5 year fd.

Why so? Because in a growing or sound #economy #investors expect to be compensated for the longer time they are willing to lock up their #money and hence want to be compensated for a higher #risk that they are taking

Inverted yield curve looks like one below

What does it mean? It means interest rates on short term notes or bonds is higher than interest rates on long term bonds. Meaning that investors are more worried or less confident about near term and want to be compensated for that. They fear it to be #volatile

Now why is US 10 year bond yields so important? 10-year yield is generally a benchmark for loan rates,etc. Also seen as sign of #investor confidence.

When in #economy confidence is high, investors feel they can take risk, and get higher returns by investing in securities less safer than us 10 year bonds (deemed usually as safest) , thus price is these 10 year bond drops and vice versa

So an inverted yield curve in the past as well has generally led up to a slowing in economy or a recession. Also less interest rate on long term bond means, investors are also not worried about #inflation which speeds up in a growing economy.

Also indicates investors think #Fed will cut short term interest rates to boost slowing economy.