FLAT YIELD CURVE. BEST NEWS, OR BORROWER BEWARE?
A Flat Yield Curve
In our post entitled A Flat Yield Curve, we discussed the implications of a flat yield curve. At the time of the post, early summer 2018, rates were rising. The reverse seems now to be true, with rates recently softening, however the results are similar, a flat yield curve.
Typically a yield curve (returns one could expect on Government debt instruments) is positively sloped. That is to say that longer term yields, and by extension interest rates, are higher than shorter term yields and rates.
Why is this so?
Why? In simple terms, investors tying up their funds for an extended period, take on an extra element of risk, vs. short term investors. The risk is the uncertainty facing an investor. Economic conditions, namely monetary policy, inflation, and the general state of both the global and national economy, are difficult to predict in the short term, let alone for a period of years into the future. The result is a higher yield typically available to an investor for a longer term. Hence, a positive sloping yield curve.
At times over the past decade, the gap between short and long term yields have pushed as high as four percentage points, or 400 basis points in investment speak. Earlier this week, the difference was hovering around 10 basis points. Flat as a pancake.
What are the implications?
What are the implications of a flat yield curve, or even an inverted one (where long term yields dip below short term yields)? Quite possibly nothing at all, however inverted yield curves have historically occurred right before every single North American economic recession. Do they predict recessions, or do they simply accompany recessions? The jury is still out on that.
What are the implications for borrowers? Again, it likely depends on your investment strategy. If you are a buy and hold investor, perhaps consider going long with your debt. In absolute terms, rates are low by historical measures. You will not be penalized at today’s rate levels, for seeking a longer term for your debt.
– by Allan Jensen