Die Heuning Pot Literature Guide
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Finance Glossary

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Yield Curve

Definition:

In this document we’ve covered far too much analysis and not enough stories in my opinion but there’s one more analytical tool you must have on the top of your head before you dive into the recruiting pool: The Yield Curve.

The YC is simply the graphic representation of what investors believe will happen to interest rates in the future. Here’s the story: The U.S. government has a ton of bills to pay. They keep our troops strong, our interstate highways clean, and our White House lights burning bright.  

To pay for all of this, the U.S. government like all governments exploits its opportunities to run the best business in the world in printing its own money. This money goes out into the marketplace in the form of T-Bills, T-Bonds, and T-Notes... all various and sundry forms of bond paper backed up by the U.S. government’s ability to collect taxes from the paltry coffers of its humble subjects.  Each week there is an auction and paper is sold to flippers - investment banking traders who will buy the bonds with yields of 5.217% and sell them for yields of 5.222%. It doesn’t seem like much of a spread but when you pump trillions of dollars through the pipeline, it adds up. 

Here’s what a yield curve looks like: 

Yield Curve

Notice a few things about it. The vertical axis is the interest rate paid and the horizontal axis is time. Notice that over the short term, money is ""cheap""... around 1% for 1-year paper. But also notice that as we move out 10 years, the yield curve is flirting with 4%. What this curve is saying is that investors believe that 10 years from now, odds are best that bonds will be trading around 4%. 

The curve is now said to be positively sloped because rates today are lower than they are expected to be in the future. But in the Carter years the curve was inverted... negatively sloped. At one point prime rate hovered around 20%. But investors believed it would come down and the yield curve settled in around 10% 10 years into the future.

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