CURRENCY TRADING
Are Things Different This Time Around?
The Inverted Yield Curve
by Kathy Lien
An inverted yield curve has implications in regards to the
US dollar and the economy. Will they both suffer?
The potential of a yield curve inversion
has been a major topic in the markets over the past few months. With two-year
US Treasury bonds yielding 4.60% at the time of this writing and the 10-year
bonds yielding 4.31%, the fear is a valid one. The spread has been shrinking
for months now, with the first inversion between the two- and 10-year notes
occurring in the last week of December 2005. This is the first time that
the spread has gone negative since 2000, which was right before the burst
of the tech bubble. Interestingly, the inversion, which is believed to
come hand in hand with a recession, has not caused a wave of panic because
many experts believe that this time around, things will be different.
Whether or not it is different will remain a debate only time can settle,
but in the meantime, what we do find interesting is that contrary to popular
thought, yield curve inversions are not necessarily bad for the US dollar.
DEFINING THE YIELD CURVE INVERSION
Before we discuss what an inverted yield curve is, it is important to
understand what a normal yield curve and an inverted yield curve look like.
In a healthy yield curve, short-term interest rates are lower than longer-term
interest rates because investors need to be compensated for taking a higher
risk by purchasing a bond with a longer maturity (Figure 1). An inverted
yield curve occurs when the short-term interest rate is actually higher
than the long-term one (Figure 2).
FIGURE 1: STANDARD YIELD CURVE. Here, the short-term interest
rates are lower than longer-term interest rates.
...Continued in the April issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the April 2006
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2006, Technical Analysis, Inc.
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