What’s An Inverted Yield Curve and Its Investments Affect?

If you’ve been watching financial news lately, you may have heard discussion about the Federal Reserve (Fed) raising interest rates. Some analysts fear the rise in interest rates may invert the yield curve. What does this mean?

The Fed and Interest Rates

Banks typically take their cues from the Fed when it comes to interest rates. If the Fed raises interest rates, then many banks will raise their prime rates. This means borrowing money for personal loans, business loans, car loans, and mortgages becomes a bit more expensive. The Fed takes it upon themselves to raise and lower interest rates based on the economy. Increased interest rates are meant to slow down the economy The opposite holds true: lowered interest rates spark “cheaper” loans and a rush to borrow money to create or expand business.

Since the economy consists of many interwoven pieces, the raised rates will affect areas like business profits, consumer spending, and of course investments. Typically, when the Fed raises rates, stock market activity decreases. (1) Theoretically this means investments may not generate as many returns as prior to the raised rates.

Treasury BondPlotting the Yield Curve

The yield curve plots the returns of bonds based on time to maturity. This allows an at-a-glance visual of what investors can expect for specific bonds. To say the curve is inverted, means the short term yields are higher than the long term yields. This means people will make more returns if they invest for the short term rather than the long term. It would be riskier to invest long term. When many people are hesitant to invest funds for the long term that means less money being loaned to new businesses getting off the ground, less real estate purchases, less car sales, etc. Compounded, this can lead to a recession.

Should I Stash My Retirement Savings Under the Mattress?

The yield curve and raised interest rates are related, but not inextricably linked. When discussing the yield curve, one must remember to think in relative terms. (2,3,4,5) For the economy, that means considering Nominal Gross Domestic Product (GDP). Nominal GDP is determined by adding inflation rates to real growth rates. Therefore, in the US, Nominal GDP is ~3.5 percent, in Germany it’s ~1.6 percent, and in Japan it’s ~0 percent over the last few years.

Then consider interest rates in relation to Nominal GDP (2,3,4,5). For the US compare the ~3.5 percent Nominal GDP to our ~1.6 percent interest rate, that’s a 1.9 percent difference, or interest rates are ~1.9 percent lower than the Nominal GDP. In Germany the difference is about ~1.6 percent, while in Japan it’s a ~0.2% difference. Therefore, out of the three countries, the US has the lowest interest rates when compared to Nominal GDP.

Being cautious is important, especially when it comes to saving for retirement, but stressing over worries of worst case scenarios isn’t going to make life better or saving easier. Working with a financial advisor may help disperse half-truths and instill some confidence in your financial plans.

Whether you have a dollar or a million dollars in your retirement account you will be able to explore the value of a real advisor simply by visiting the Self Directed Brokerage Account advisor contact site. From this site you can begin to take advantage of the features of your retirement plan.

  1. http://www.foundationsforliving.org/articles/foundation/fedraiselower.html
  2. http://www.ftportfolios.com/Commentary/EconomicResearch/2016/7/20/will-the-yield-curve-invert
  3. http://www.cnbc.com/markets/
  4. http://bea.gov/national/index.htm
  5. http://yieldcurve.com/marketyieldcurve.htm

To learn more about Rick Willoughby, view his Paladin Registry research report.  

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