Question

Does the shift of the yield curve predict the stock market in the future? Why?

Answer 1

Normal yield curve is upward sloping which implies that the investors expect a higher interest rate as the maturity of securities increases. However there are times when the yield curve gets inverted which means that a higher maturity is complemented with a lower interest rate.

This indicates recessionary trends and that affects the stock market. Investors do not invest in the stock in times of recession. The short end of the yield curve shows the interest rate which is set by the Federal Reserve. The curve Steepens mainly because the fed lowers the fed funds rate and flattens when the rate increases.

When the yield curve gets inverted it is a strong signal to the economy because the short-term yield increases as compared to long term yield which is both contradictory and surprising. This motivates the investors to hold on to their Investments and indicates a slow down which lowers the stock prices.