Yield Curve

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The Yield Curve is a Powerful Predictor of Economic Growth. Here's Why. Imagine you're at a cocktail party and someone mentions the economy. The conversation might go something like this: "I'm worried about the future," says John, a concerned citizen. "The economy has been slow lately." His friend, Jane, chimes in, "But I've heard that the yield curve is looking good. That's got to mean economic growth is around the corner." What exactly does the yield curve have to do with anything? To understand why it matters, let's take a step back and look at how the economy works. In simple terms, the yield curve shows us how interest rates change over time. It's like a big line that graphs out the rate at which you'd expect to earn money from lending someone else cash for a year, versus lending them cash for five years. The basic idea is this: if you lend someone $100 for one year, you should get about 1 percent of it back in interest - or $1. But if you lend that same person $100 for five years, you'd expect to get more than 5 percent back in interest - maybe around $6. The yield curve shows us how these rates change over time. It's like a big line that graphs out the rate at which you'd expect to earn money from lending someone else cash for a year, versus lending them cash for five years. If the yield curve is steep and rising, it means people are more likely to lend money for shorter periods of time - which can be good news for economic growth. In fact, research has shown that when the yield curve is steep, economic growth tends to follow. That's because when people have confidence in the economy, they're more likely to invest their money and take risks - like starting a new business or buying a house. This increased investment helps drive economic growth, which in turn creates jobs and raises incomes. But what happens if the yield curve is flat or even inverted? In that case, it can be a sign of trouble ahead. When people are less confident in the economy, they're more likely to hoard their cash - rather than lend it out. This reduced investment can slow economic growth, making it harder for businesses to hire and pay workers. So what's happening with the yield curve right now? Take a look at this interactive chart, which shows how the yield curve has changed over time. As you can see, it's been trending downward in recent years - meaning that interest rates have been rising across the board. This might seem like good news for economic growth. But remember: just because interest rates are rising doesn't mean the economy is necessarily growing faster. In fact, research suggests that when interest rates rise too quickly, they can actually slow economic growth down. So what does this all mean for you? If you're worried about the future of the economy, take a look at the yield curve. It might just give you a hint about what's to come. Note: The original text is from http://www.nytimes.com/interactive/2015/03/19/upshot/3d-yield-curve-economic-growth.html