Important update: Stake UK will be closing down.
Read more here
When you invest, your capital is at risk.

by Stella Ong
Share

Yield

Bonds may seem less exciting than stocks and real estate, but many think that they’ve got one unmatched superpower: the ability to predict economic recessions.

As fixed income securities, bonds pay a set amount of interest periodically based on their coupon rate until they reach maturity. But bonds can also be traded on a secondary market and experience the same price volatility as stocks; these are known as “exchange-traded bonds”. An ETB’s return is determined by the bond yield, which is its annual interest payment divided by its market value.

Since World War II, the bond market’s yield curve has accurately flashed warning signals of incoming economic recessions. As a graphical representation of bond yields across different maturities – from short-term bonds to long-term bonds – the yield curve normally slopes upward. It makes sense for short-term bonds to have lower yields than long-term bonds after all – you expect higher returns for a longer-term investment. 

But abnormal circumstances can cause the yield curve to invert. That’s right, the graph becomes downward-sloping, meaning that short-term bonds have higher yields than long-term bonds. This happens when investors become pessimistic about economic prospects in the near future and move away from short-term bonds to pile into long-term bonds. The latter’s market value increases, leading to lower yields when calculated as above. 

It may sound extremely simple, but a yield-curve inversion has preceded the last seven recessions, including the burst of the Dotcom Bubble and the GFC. And based on this history, the recession usually comes about 15 months after a yield curve inverts.

Interested in what the yield curve looks like right now? Well, it’s inverted. But while its predictions have been accurate so far, it’s also the first time in history that it’s succeeding a global pandemic. Investors, at the very least, seem to be largely optimistic about the market’s outlook. Let’s see whether the yield curve's predictive streak continues or if we finally get to say the indicator raised a false alarm.


Portrait photo of Stella Ong, Markets Analyst at Stake.

Stella Ong

Markets Analyst

Stella is a markets analyst and writer with almost a decade of investing experience. With a Masters in Accounting from the University of Sydney, she specialises in financial statement analysis and financial modelling. Previously, she worked as an equity analyst at Australian finance start-up, Simply Wall St, where she took charge of the market insights newsletter sent out to over a million subscribers. At Stake, Stella has been key to producing the weekly Wrap articles and social media content.


Related


Want more?

You know what to do

Insights, trends and company deep dives delivered straight to your inbox.


Stake logo


Stake is the trading name of Hellostake Limited, a company registered in England and Wales (Company no. 11676409). Hellostake Limited is authorised and regulated by the UK Financial Conduct Authority under the Firm Reference Number 830771. Registered address: 85 Great Portland Street, London, W1W 7LT, United Kingdom.

When you invest, your capital is at risk.

The value of your investments can go down as well as up and you may receive back less than your original investment. Any advice is of a general nature only. As investments carry risk, before making any investment decision, please consider if it’s right for you and seek appropriate independent taxation and legal advice. The information on our website or our mobile application is not intended to be an inducement, offer or solicitation to anyone in any jurisdiction in which Stake is not regulated or able to market its services.

At Stake, we’re focused on giving you a better investing experience but we don’t take into account your personal objectives, circumstances or financial needs. Please view our Terms & Conditions, Privacy Policy and Disclaimers before deciding to use or invest on Stake. By using the Stake website or service in any way, you agree to our Privacy Policy and Terms & Conditions. All financial products involve risk and you should ensure you understand the risks involved as certain financial products may not be suitable to everyone. Past performance of any product described on this website is not a reliable indication of future performance

Copyright © 2024 Stake. All rights reserved.