Why is an inverted yield curve an indicator of a recession💹
Here's a simple way of thinking about it🔃🔃
Here's a simple way of thinking about it🔃🔃
Imagine you go to a bank to invest your money in a fixed deposit.
The bank offers you:
A 1 - Year fixed deposit (FD) at 6% per annum and,
2 - Year deposit at 4% per annum.
The bank offers you:
A 1 - Year fixed deposit (FD) at 6% per annum and,
2 - Year deposit at 4% per annum.
The long-term rate is lower than the short-term rate.
That's an inverted yield curve.
By the way, isn't this strange?
That's an inverted yield curve.
By the way, isn't this strange?
Why would anyone invest for two
Years at 4% per annum when they
Can invest for one year at 6% per
Annum, and then when they
Receive the money after a year,
They can reinvest for one more year at the prevailing interest rate?
Years at 4% per annum when they
Can invest for one year at 6% per
Annum, and then when they
Receive the money after a year,
They can reinvest for one more year at the prevailing interest rate?
The only rational reason for anyone investing in the two-year FD would be that they expect the interest rates to fall after a year.
Hence, they want to invest today for two years.
But why would they expect the interest rates to fall after a year?
Hence, they want to invest today for two years.
But why would they expect the interest rates to fall after a year?
Interest rates generally fall during recessions.
So maybe the market is expecting that there could be a recession in the future.
Hence an inverted yield curve indicates interest rates could fall in the future.
So maybe the market is expecting that there could be a recession in the future.
Hence an inverted yield curve indicates interest rates could fall in the future.
And this could be due to a recession.
Above is just one of the ways of looking at this.
There are other ways of interpreting too.
Above is just one of the ways of looking at this.
There are other ways of interpreting too.
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