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What Is the Yield Curve, and Why Should You Pay Attention to It?

Ron Joelson •  November 2, 2015 | Ask the Expert, Your Finances

Each month, we book time with some of our company’s top financial brain power to answer questions about investing and your finances. This month we are talking about the yield curve and how it can be an indicator of where the economy is headed.

Ron Joelson

Ron Joelson is Northwestern Mutual's chief investment officer and oversees the company's general account, valued at approximately $200 billion.

Mark McLennon

Mark McLennon is vice president of Investment Products and Services (IPS) Business Development. He oversees the fee-based financial planning program and departmental growth initiatives.

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The following is an excerpt from our Ask the Financial Expert podcast (listen to the entire podcast below):

Mark: A few months ago we talked about bonds in the context of when it’s a good time to take on debt. One thing, Ron, [that] you mentioned in that discussion was how watching the yield curve can give you an indication of where we’re headed financially (interest rate changes and economic activity). So what is the yield curve, and why should investors pay attention to it?

Ron: The yield curve is really another word for the term structure of interest rates. What that means is that it reflects that at different time periods investors can expect different rates of return.

We currently have an upwardly sloping yield curve, which is a normal yield curve. So, as an example, if you were to lend money to the government for two years, you could expect to get about 65 basis points for doing that, or 0.65 percent return on your investment. However, if you’re willing to lend money for five years, because you’re taking more risk by lend for longer period of time, you’ll get a higher yield, perhaps a little less than 1.5 percent. If you go out 10 years, you’ll get a little better than about 2 percent. So, you have this upward sloping concept.

If you look back historically, the yield curve has been something of a predictor of the overall economic environment. In fact, you could think of the 10-year curve as the market’s view of what the growth rate may look like, including inflation. Think about it from an investor’s perspective. Let’s say you believe that there’s no growth or very little growth coming in the economy. Then suppose you believe that, as a result of very low or no growth, equities aren’t going to do particularly well. Then you might decide you’re just going to try to keep your money safer and buy longer-term bonds and lock in low rates.

As more and more investors do that and more and more investors believe the economy’s going poorly, that will effectively drive those prices up and lower the yield. That leads to a flattening yield curve. If it gets really bad, it will actually be an inverted yield curve, [in which] short-term yields are higher than long term.

So the yield curve tends to be somewhat predictive. If you go back in history, the last seven or so recessions were all predicted by the yield curve. In 2008 and 2006 and going all the way back into the ʼ50s, you saw the yield curve either flat or even declining prior to recessions. So it’s really something you need to keep an eye on.

Mark: The Fed recently kept rates pretty much unchanged, and that seems to have led to a flattening of the yield curve. What are your thoughts?

Ron: For investors, I would continue to watch the curve. It’s still upwardly sloping, so we’re in an okay place. But, as we just discussed, we don’t want to see a situation [in which] that curve starts to flatten or begins to invert. If the Fed does move, it’s probably going to be on the short end. That says nothing about what may happen in the middle of the curve or at the long end.

If investors think or disagree with the Fed that the economy’s growing well, it could well result in the short end going up and the long end either staying where it is or even flattening.

Hear more from Ron and Mark in the “Ask the Financial Expert” podcast:

Do you have a question for our financial experts? Email it to us at:

The opinions expressed are those of individual investment professionals as of the date stated on this article and are subject to change. This material does not constitute investment advice, is not intended as an endorsement of any specific investment or security and is not a prediction of what will happen in the markets.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. With fixed income securities, such as bonds, interest rates and bond prices tend to move in opposite directions. When interest rates fall, bond prices typically rise; and conversely, when interest rates rise, bond prices typically fall. This also holds true for bond mutual funds. When interest rates are at low levels, there is risk that a sustained rise in interest rates may cause losses to the price of bonds or market value of bond funds that you own. At maturity, however, the issuer of the bond is obligated to return the principal to the investor. The longer the maturity of a bond or of bonds held in a bond fund, the greater the degree of a price or market value change resulting from a change in interest rates (also known as duration risk). Bond funds continuously replace the bonds they hold as they mature and thus do not usually have maturity dates and are not obligated to return the investor’s principal. Additionally, high yield bonds and bond funds that invest in high-yield bonds present greater credit risk than investment-grade bonds. Bond and bond fund investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk and inflation risk before investing in a particular bond or bond fund.

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