How Important Is The Yield Curve?

Bank earnings season is off to a mixed start, and bank investors haven’t gotten the type of returns they had hoped for in a climate of rising interest rates. A major part of the problem: the flat yield curve. Here’s a closer look at what the yield curve is and why it matters.

What Is The Yield Curve?

The yield curve is a plot of the yields of bonds with equal credit quality but different maturity dates. For U.S. investors, the most commonly referenced yield curve is a plot of U.S. Treasury bonds with three-month, two-year, five-year and 30-year maturities.

A typical yield curve includes much higher interest rates for maturities further into the future. In a flat yield curve, there's little difference between short-term yields and long-term yields. Sometimes, yield curves can become inverted, a scenario in which short-term yields are higher than long-term yields. Inverted yield curves have historically occurred during periods of economic recession.

A Red Flag?

The flat U.S. yield curve at the moment may not necessarily be predictive of U.S. economic weakness down the road, said TD Ameritrade senior trading specialist Shawn Cruz.

“I'm a little bit concerned about [flattening of the yield curve], but when you think about what’s going on right now, [if] you're going to go out and buy a treasury from any sovereign country, would you go to the U.S. or another country?" Cruz said. "Relatively speaking, there’s a lot of demand for U.S. treasuries, which is holding yields down."

What To Watch 

While a flat yield curve may not necessarily be anything for investors to worry about, Cruz said an inverted yield curve is a different story.

“If it moves into negative territory, from an asset pricing perspective there are a lot of concerns that come into play,” Cruz said. “If it actually goes negative, that would be a telling moment for me where I want to make sure I manage all my risk appropriately in my portfolio.”

The flat yield curve hasn’t held back the S&P 500 so far this year. The SPDR S&P 500 ETF Trust (NYSE: SPY) is up 4.6 percent year-to-date.

Related Links:

Paul Tudor Jones Talks Trade Wars, Interest Rates, Charity In The Private Sector

Federal Reserve Raises Interest Rates For Seventh Time Since 2015