What Is An Inverted Yield Curve?

You can see it here under the column titled “Yield.” The 5yr note has a yield to maturity of 2.6972% a year. The 10yr note (the most important single number I can name in global financial markets) has a yield to maturity of 2.554%

You can see that 2.6972 > 2.554, which isn’t “normal,” whatever that means. In this instance, they say the yield curve is inverted.

No Arbitrage Allowed

The real point is that this creates something called a “five year rate, five years forward.” That looks and sounds like jargon, and it is.

But, some math will show the way.

If you invested $100 for 10 years, it would be worth 100 x (1.02554)^10 which reflects the compounded interest for 10 years.

If you invested $100 for 10 years, it would be worth 100 x (1.026972) ^ 5 which reflects the compounded interest for 5 years.

The result is that you can calculate what the market believes to be the 5 year interest, starting in 5 years.

You know what the end of today to 10 years will be = 128.68444146

You know what the end of today to 5 years will be = 114.233376659

In five years then, you will get 114.23 after 5 years, and the market is currently saying that it will be worth 128.68 after the next five years. That is the five year rate, five years forward.

That math is (126.68444146 / 114.233376659)^(1/5) = 1.02090669837 – 1 = 2.090669837%. You can see how much lower this is than the current 5yr note yield, which is 2.6972%. This reflects the market-neutral position of where the 5yr note will be, after 5 years have elapsed. When that forward rate (2.091%) is lower than current 5year rate (2.6972%) »> this is a predictor of recession.

You do not need to know how to calculate, but the intuition, the rationale, is important.

*Actual bond jocks can stop criticizing the shortcuts I have taken, gimme a break.

The First Step Is A Crazy Background

Paid subscribers can hopefully conclude one thing: the likelihood isn’t very high, that I have created this set of articles, out of thin air, on top of my head, as fast as I could type. We are not close to finished revealing everything.

BTW, I signed this, I must be the April Fool.

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