Question

For the companty match.inc (tinder) how does the bond market predict the future economic environment the company will operate in? Can you find the current information on this predictor?

Answer 1

Solution :

The bond market can predict the future economic environment in which the company is going to operate and that is possible because it is considered as the indicator which reflects the investor's expectation.

It is largely driven by the expectation and the bond investors as a group are largely seen as being “smart money” and less prone to the type of speculation seen in stocks or commodities.

It is fairly strong track record as a predictor of economic conditions, and for that reason, they are often used by economists as a leading indicator. The major tool or the methodology you can say in order to predict is the “YIELD CURVE.”

The “yield curve” measures the return on the bond starting from 3 months to 30 years depending on the varying maturities. Since yields for bonds of all maturities change every day due to market fluctuations, the “shape” of the yield curve is always changing – and these changes provide insight into the economic outlook.

There are different returns in terms of short term or long term bonds and depending on that the current market value of the bond fluctuates and the yield is determined. The performance of short-term bonds which are less than 12 months is most directly impacted by expectations regarding future Federal Reserve policy with regard to the federal funds rate. The performance of longer-term bonds which are more than 12 months are more volatile and is largely driven by the outlook for inflation and economic growth rather than Federal policy.

The important aspect of this relationship to understand is that while short-term yields are “pinned” to some extent by expectations for the Fed’s rate policy, longer-term bonds experience higher volatility based on shifts in the broader outlook. Expectations for the economy, therefore tend to have a strong influence on the shape of the yield curve.

Let me explain how the shape of the yield curve changes: when the yields on long-term bonds rise faster than those on short-term bonds (which indicates that long-term bonds are underperforming short-term bonds), the yield curve is “steepening.” This typically indicates an environment in which investors see stronger growth ahead.

On the other hand, when yields on short-term bonds are rising faster than the yields on long-term bonds (or in other words, short-term bonds are underperforming)the yield curve is said to be “flattening.” This is usually an indication that investors see slowing growth ahead.

On rare occasions, the yield curve can become “inverted” meaning that short-term bonds yields are actually higher than long-term bond yields. When this is the case, it indicates that investors see a high likelihood of a recession or even a potential crisis ahead.

In short, it is explained as a yield curve that is steep or becoming steeper is a sign of expectations for improving growth; a yield curve that is flat or becoming flattered is a sign of expectations for slowing growth and not a good prospects to invests.

Thank you.