What is a Yield Curve and How it Works: Essay

Category: Economy

Yield Curve


Generally, a yield curve is usually a line used in the plotting of interest rates usually at a point set in time for bonds that have equal credit but differ in maturity dates. The shape of the yield is normally closely scrutinized since it helps in giving an idea of future interest rate change and economic activity. Over the course of the week, beginning Monday, October 28, 2013 and ending Friday November 1, 2013, the entire yield curve rose. Since the yield curve normally shows the relationship between the short- and long-term interest rates of fixed income securities, its rise over the stated period was an indication that the long-term security rates rose beyond the shorter security rates because of the low maturity risks. 

Normally, an increase in the yield curve means a raised forecasted one-year rates based on expected hypothesis. In this case, the interest rate forecast seemed to have been boosted by the slight rise in mortgage rates after a fall that was experienced last week. As pointed out by Mangaroo (2013), the fixed mortgage rates have moderated slightly over the short term as uncertainty lingers over the American debt ceiling. This has continued to drive investors to a safe haven for investment. It has also prompted lenders to conservatively lower their fixed mortgage rates offerings. However, the slight rise in the rates saw the average rate for 30-year fixed mortgaged rise from 3.60 percent last week to 3.61 percent this week as the average on the 20-year fixed loan rose to 2.54 percent from 2.53 percent (UDT, 2013). Similarly, an increase in yield curve on Monday to 2.1 percent was an indication that the prices of bonds decreased throughout the year.

On Tuesday October 29, 2013, most lenders’ sheets were essentially unchanged compared to the day before as the curve rose slightly higher from Monday to Tuesday. The Dow chemical price rose to 1% as the NASDAQ premium income and growth common price rose 0.5% (Graham, 2013). When this is compared to the previous years spending, it showed that there was an increase of 0.52 percent in the index of inflation tied to spending patterns. In addition, Tuesday was not marked with market tanking even as the partial government shutdown led to market speculation that the Federal Reserve will not alter its bond purchases this year thereby adding to the weak employment expectations. Despite all these, the stocks still ended higher on Tuesday at 2.3 percent. This rise was due to the fact that the equity returns had started to outperform fixed income returns thereby signifying a positive equities value. Thus, the market was expected to steadily pick up.

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As was expected, the yield curve rose from Tuesday to Wednesday by a marginal percentage. While the lowest point of the day was at 0.05 percent, it picked up to finish off the day at 2.4 percent on one-year rates based on length of maturity. This was attributed to by investment opportunities that were aimed at countering shareholder’s high rate of borrowing. For instance, there was the removal of verbiage by the Federal Reserve. It reduced risks associated with tight financial conditions. It was on the same day that Deloitte, a leading global financial market and provider of advices towards expanding businesses, sponsored a first-ever selected U.S. investment summit. It was meant to help various stakeholders by giving them an insightful understanding of such areas as taxation, business incentives, regulatory environment, and human location strategy. While the total bond size was not determined for this particular day, it was expected to have no big loss by the end of this week.

Consequently, there was very a little and a slight increase from Wednesday to Thursday, a projection that is expected to rise at the end of the week. The yield curve finished at 2.4 percent and maturities cut rose from the starting rate of -0.5 percent. At the same time, the U.S stocks closed higher by a small margin. There was a flurry of up and down corporate earnings that rattled the market early during the day. According to Gordon (2013), this was attributed to the fact that trading had been choppy as investors took cues from the economic data and company-specific news.

On Thursday, mortgage rates remained higher. Like on Wednesday, Thursday recorded stronger-than-expected economic data (OANDA, 2013). For instance, the rise in stock prices throughout the week, especially from -0.5 percent starting rate to 2.4 percent made investors and scholars to look for ways of how to understand the market trends using security prices. In addition, from the steepness of the curve that slash out as Friday close down was an indication that more money was being sent into safer, less volatile investment. The closer of interest rates at 2.49 percent on Friday was an indication that investors adjusted to expectations that the Federal Reserve will inch its way out of its easy-money policies. 

In this regard, the overall increase in yield curve throughout this week indicated that at times steepens, fear, and rush for safety actually dominate the markets. There is the possibility that rates will continue to rise as the technical trend matures.