Question

Negative Yield Curve

a) Is the yield curve usually positive, or negative?

b) What are the implications of a negative yield curve? In other words, what economic conditions does a negative yield curve indicate (other than long-term rates are lower than short-term rates)?

Answer 1

Ans A:

A normal Yield curve generally trends upwards indicating that the long term interest rates on debt securities / instruments are higher than the short term interest rates.

Generally yield curve is positive.

The normal yield curve is also termed as postive which indicates that long term interest rates are higher for the simple reason that investors are tying up their captial for longer period. Hence they require higher returns for the risk exposed.

The negative yield curve indicated that the short term interest rates are higher than the long term rates on debt securities. If investors feel that long term prospects are not that attractive than the short term prospects, it results in an inverted yield curve.

ANS B:

The negative yield curve is a function of short and long term rates. short term rates rates are managed thru open market opertions.If the short term rates are raised it shall limit credit growth.

Generlly banks prefer to lend to projects with visible cash flows and faster repayment of the captial. If short term rates are favorable bank lends for multiple smaller projects, than long term infra projects. hence long term debt funding projects get reduced. This may affect consumption and capital churning in the economy leading to recession.

As a thumb rule, the long term treasury rates are proxy for economic growth.If long term rates are low and short term rates are high then it signals that the future economc prospects are weak and may lead to weak economc growth.