Not quite that. The yield for a 5-year note is less than the yield for a 3-year note.

More generally, a yield curve inversion is when the interest rate you earn on short-term debt ends up higher than that of long-term debt of the same quality.

I don't think the issue is that the inversion causes the recession. It's more an indicator of pessimism in the market. It implies that investors think that interest rates are going to get worse, so they look to buy more longer-term bonds in order to try and lock in current yields for a longer period of time. That increases demand for those assets, which drives down their price^H^H^H^H^H yields.

> That increases demand for those assets, which drives down their price.

I'm not an economist but this seems wrong

Actually it does not drive down the price but the yield. When the price goes up the fixed payment is a lower fraction of the price of the bond. Hence the return goes down.

https://www.investopedia.com/terms/b/bond-yield.asp

He made it most of the way there. Increasing demand drives UP prices, which drives DOWN yield.

This was corrected above, but for those who are interested: For bonds, yield and price are inversely related.

Buying a bond means you are lending money now, in return for more money later. The amount you get later is made up of the price you pay now plus the interest, ie the yield. So if the yield goes up, the price goes down. (You don't have to pay as much for a bond when the yield goes up).

That commenter should've said the yield is driven down. The US government wants to borrow at the cheapest rate of interest. If more people want to lend to them, they have more options and can pick the cheapest option.

> The US government wants to borrow at the cheapest rate of interest

This is categorically not true. If it were then Congress would pass legislation ordering the Fed to buy securities from the Treasury at whatever rate it liked (or abolish the Fed altogether and just directly spend money into existence). Congress in fact wants to provide savings vehicles, it's not actually necessary for Congress to borrow to fund the federal government. Sure it's necessary under current law but Congress by definition can change that law. That it chooses not to is an expression of a preference.

Drives down their yield would be more correct, which is to say the asset becomes less profitable.

Haha, gotcha. edited.

yes, OP meant drives up the price and drives down yields

But it's not just the bond market in isolation that is relevant, it's the possibility that money moving into longer term notes could mean that people are making bets that nothing in the overall market will yield more than the long term debt instruments.

Ah, so this is basically the market saying the US government's ability / willingness to pay debts today is greater than it will be in the future?

Or is it simply about interest rates, I guess, since higher interest rates cool the market and lower interest rates warm the market. So investors are thinking a recession is coming and the Fed will need to lower interest rates to stimulate.

I don't think it's that - US Treasury Securities are always regarded as being nearly as safe as cash.

But, in a recession, the stock market tends to nose dive, which prompts a lot of people to flee to fixed-income securities because they're viewed as being safer. Which would also drive down yields.

Great, thanks for your help. I'm understanding much better now about how bonds are priced and how it relates to their yield. :)

> US Treasury Securities are always regarded as being nearly as safe as cash

Not always:

https://en.m.wikipedia.org/wiki/United_States_federal_govern...

From the page you linked:

"Market consequences ... U.S. treasury bonds, which had been the subject of the downgrade, actually rose in price and the dollar gained in value against the Euro and the British pound, indicating a general flight to safe assets amid concerns about a European debt crisis.[31]"

Basically, no one believes rating agencies with respect to the US paying its debts - but they do believe that if the US government is in chaos, it will be bad for the world economy.

One should also remember that US bonds are denominated in US dollars, which the US government can print. Also, if you're comparing to "cash" you probably mean "US dollars" which are backed by the "full faith and credit" of...the US government.

For many years the US federal government wasn't rated at all, because it was correctly seen as the absurdity that it is[1].

[1]https://tradingeconomics.com/united-states/rating

Not quite that.

Bond prices go down when interest rates go up. As such, an investor who thinks that interest rates will go _up_ will reallocate from long-term bonds to short-term bonds, rather than the opposite as you stated.

Actually they still pay a positive amount (about 2.8%/year). What's significant is that now the 3 year pays slightly more than the 5 year (2.84% vs 2.83%). Usually longer term treasuries pay more because the buyer assumes more risk to have their money locked in to a specific rate for a longer term.

However, when the market expects that maybe interest rates will be falling in the near future (like in a recession), it can prefer to lock in the current rates for a longer term. When markets expect recessions, people tend to buy long term treasuries over short term treasuries which causes the yield of long term treasuries to go down and the yield of short term treasuries to go up.

If my understanding it correct, I'm pretty sure it means the yields of short-term investments are better than long-term investments with the implication that investors feel like the economy is fine now but won't be in the not to distant future. In short, they think there will be a recession so they want to make money now while the gettin's good.

In the article there is actually a link hidden that provides just that info

> Click here for a QuickTake on the yield curve

https://www.bloomberg.com/news/articles/2017-12-11/the-yield...

Oh awesome, thanks!

It's significant because an inverted yield curve is a historical indicator of an impending recession.

https://www.nytimes.com/2018/06/25/business/what-is-yield-cu...

Here's a YouTube video illustrating it quite nicely IMO: https://www.youtube.com/watch?v=tZwChe0WvO4

For whatever reason, if people are optimistic about the market, the yields are higher long term versus short. (You need to get paid more interest to hold a 10 year bond than 2 years because you assume the rates go up)

The general reason people think rates will go down in the future is if a recession is coming, and the govt will lower them. In this case the rates may high for 2 years, but lower long term. (The 10 year rate is just a weighted average of interim rates)

Why would rates go up in an economy that is getting better? Is it only because the Fed would increase rates in response to the improvement? In a free market, I imagine they would go down because people would trust the government's ability to pay back their bills and thus bonds would be more in demand?

It’s not credit risk of the govt. It’s the govt raising rates to slow down inflation. (In a downturn, prices go down, so rates can be lowered without an inflation risk)

Treasuries (i.e. bonds) are issued for different terms, such as 3-year and 5-year terms. Typically longer term treasuries have higher yields because you're loaning your money for a longer period.

The Yield Curve™ is the difference between the yields of two treasuries -- in this article it is the 5-year Treasury note minus the 3-year Treasury note. When this difference is negative that means the 5-year note has a lower yield than the 3-year note.

Investors typically want the highest yield possible, so they'll invest in the 3-year note rather than the 5-year note. A negative spread (difference) can indicate that investors are more confident about the short-term than the long-term.

Note there isn't really a single "Yield Curve". You can take the spread between any two terms of a Treasury note -- e.g. the 30-year and 10-year or the 10-year and 2-year notes. The Federal Reserve provides a spread for the 10-year minus 2-year: https://fred.stlouisfed.org/series/T10Y2Y

A yield curve typically means taking not just two instruments, but as many as you can get, so there really is just one yield curve for any given kind of instrument.

Although there is enough variety in the details of government bonds that you could argue there is more than one there. The proposition that there is a single yield curve is more obviously true for things like interest rate swaps.

It's a potential warning sign of a coming recession:

https://en.wikipedia.org/wiki/Yield_curve#Relationship_to_th...

It means institutions aren't betting on the long term growth of the economy and instead are tryna capture short-term gains.

No - what happened is the yield on the 5 year treasury dropped below the 3 year one.

chadash wrote a nice explanation further up in the thread

Sorry for the copy pasta, but they say it better than I do.

"Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed."

https://www.investopedia.com/terms/i/invertedyieldcurve.asp