While the 30 year Treasury bond was once the benchmark around which all other bond prices were based, recent decades have seen the 10 year bond take its place. One of the reasons for doing this was to establish a sort of equilibrium point between so-called short-term and long-term bonds, with the 10 year being considered to be the middle of the spectrum.
This permits traders to look at what is known as the “yield curve” in order to gain insight into which way the economy is moving. Under normal conditions, the less-risky short-term bonds carry a lower interest rate than the 10, while longer term bonds carry higher rates due to the uncertainty inherent in lengthier time lines.
During times of disruption, however, the yield curve can invert, which means that people are starting to demand higher rates on than on long-term ones. Presumably because nobody wants long-term bonds at all and demand a premium for taking any sort of risk in terms of loaning money even for a short time.
In essence, yield curve inversions are counter intuitive. Why would somebody be willing to loan money for 30 years at a lower rate than they would for one or two years? It is indicative of a market sentiment that is reluctant to loan money at all but is willing to extend some shorter term credit at a higher risk premium. Longer term bonds should technically rise as well, but they do not simply because nobody is buying them under these market conditions.
Instead, longer term bonds, even including the 10 year bond, tend to “roll off” or be redeemed at their expiration date and are not taken back up again. Instead, that money flows into other assets perceived as being safer. This can include short term bonds at a higher interest rate or may also involve moving the money out of bonds and into other asset classes such as the stock market or commodities trading.
In any case, yield curve inversions mean that traders are going to be extra careful in how they allocate their portfolios and do not want to get tied up in any assets which they cannot easily get out of on short notice. Yield curve inversions are seldom long-lasting phenomena but they do suggest that something is not working properly in the financial markets. Once the yield curve is driven back to its normal shape, traders resume their ordinary inverting programs as if nothing had happened.
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