Right, think I might have been clearer on the difference of interest rate vs yield.
If people start selling fixed income instruments, the price of the instrument goes down. Say we're talking treasuries. If the price of a treasury goes down, it is cheaper to buy, but you still get the same interest rate (based on original notional/face value). Thus the yield is higher.
So investors are indeed not setting the interest rates, but they do drive the price down, thus increasing the yield.
I suck at explaining things clearly, so I hope this makes sense to you
TIPS are inflation protected securities. You can also buy just standard 'fixed' securities.Which treasury securities can be sold? I know that TIPS can be sold, which other one's can? I buy 4-week treasury bills and i just wait 4 weeks and the money is back in my bank account.
Investors and traders start to expect lower future rates that's why it becomes profitable to buy long-term bonds now instead of purchasing short-term and then rolling over proceeds at future rate. That forces long-term yield to move down and short-term yields to increase.This is taken for granted in the general news media that an inverted yield curve is an indicator or a recession. How is an inverted yield curve a sign of an economic recession?
Markets expect interest rates to fall not because of Central bank stimulus actions but because investing in longer-dated bond will yield higher return that investing in short-term and then rolling over proceeds investing into next short-term bond.Investors of bonds demand to be compensated for time risk (which incorporates other kinds of risks changes in interest rates, inflation etc). Therefore under normal conditions, you should have an upward sloping yield curve the 30 yr > 10 yr > 1 yr > 1month etc.
Yield is a function of price and coupon relative to other bonds but in terms of fixed income, it's fixed at inception unless it has a floating element which is not applicable as far as I am aware to government bonds. Remember that government bonds (US) are seen as risk-free. Therefore, we do not (although we theoretically could) price in default. Price, therefore, is more or less purely a function of supply and demand for a risk-free income.
Therefore, if prices rise yields fall if prices fall yields rise.
If the yield curve inverts then investors are purchasing the long-dated bonds to such a degree that the yield drops below near term yields (pushing the back end of the curve down). This is because expectations are that the market will fall therefore interest rates will fall in an attempt by central banks to stimulate the economy. At the same time investors may be selling short term bonds to buy long term bonds increasing short term yields (pushing the front end of the curve up).
This inversion of the yield curve doesn't have to lead to a recession but all recessions have an inverted yield curve prior to the recession.
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