If the yield curve for zero coupon bonds is decreasing does it mean (in general) that investors are thinking that country's economy has gloomy future? Or unpredictable?

  • 1
    $\begingroup$ Please be more clear. Explain what a "zero-coupon bond" is. Also, a "yield curve" is, a curve, a collection of points. In what sense it is "decreasing"? You mean shifted downwards as a whole for all maturities? $\endgroup$ – Alecos Papadopoulos Apr 2 '15 at 4:47

In short, the yield curve represents the expected path of future short term rates. This is under the assumption that investors are free to choose between investing consecutively in x number of short term bonds and one long term bond for x number of periods (e.g. buying five one-year bonds consecutively and buying one five-year bond). This assumption results in the term interest rates being equal to the expected average overnight rate to its maturity.

Therefore, if the yield curve is downward sloping (or "inverted"), this simply means that investors expect short term interest rates to decrease in the future. Anything beyond that is inference. However, the main reason for a central bank to lower interest rates would been the case of a recession. This is why the inverted yield curve is seen as a good alert for recessions. In fact, an inverted yield curve has predicted all nine recessions in the US since 1955, although it is still difficult to predict the timing of the recession.

To succinctly answer your question of whether an inverted yield curve signals a gloomy future or unpredictability, the inverted yield curve shows investors expect short term interest rates to decrease, which can be an indicator for a recession. The yield curve represents the expected future path of short term interest rates. In other words, the path of the yield curve is based on the expectation, not the variance of the expected short term rates.

You may also find the discussion here useful for your question.


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.