In the world of stock marketing, the yield curve is a good indicator of many factors ranging from inflation to investment returns. For this reason, the yield curve is one of the most trusted sources of information on the part of investors and analysts alike. The yield is of three types depending upon the market situation, depending upon the prevailing mood of the market – an upward curve, a flattened curve and an inverted curve. Out of these three, the flattened curve is the expert at creating havoc among the investor community.
A flattening yield curve is created when the difference between yields on short-term bonds and yields on long-term bonds decreases. This happens when the market perception results in a carry-over of little benefit in holding a long-term investment as part of an investor’s portfolio. The curve is a consequence of long-term interest rates witnessing a steep fall with respect to short-term interest rates. The flattened yield curve may also be obtained when the short-term interest rates increase enough to be on a comparable level with the long-term interest rates.
The flattened yield curve is usually a source of panic among the investors, which unexpected news of a rollout of funds usually coming out as a consequence of the flattened curve. When the curve indicates that future inflation rates are showing a falling trend, investors are bound to ask for higher long-term rates to make up for the lost value from short-term investments since inflation reduces the value of an investment in future along with the investor nature of demanding higher returns in favourable conditions. Over-expectation of this nature from the market further sets the flattened yield curve in motion.
Sometimes, the flattened yield curve can occur purely due to market perception on the future economic policies of the government and the treasury. This usually happens when the investors are in anticipation of slower economic growth in the market. In other cases, it may also flatten due to the decisions made by the Federal Reserve. If the Federal Reserve increases its short-term financial target, it may increase short-term interest rates in the market for a stipulated period of time to achieve its objective. While this may result in an increased flow of capital into the reserve, it will also lead to an increase in short-term lending rates which may even out the rates offered in the long term, thus evening out the yield difference.
A flattened yield curve may also send the funds offering long-term investment plans in a tizzy as panicked investors seek to remove their money from the long-term investment plans to pump into the short-term plans in order to make a quick buck. A butterfly effect on the interest rates kicks off as a consequence of lowered interest rates after the pull-out of the capital, which may result in restoration of the yield capital to a steep upward yield curve.
A flattened yield curve is nothing to be worried about by the investors unless the ominous signs of a long-term recession are on the horizon. Investors are encouraged to weather the storm created by a flattened yield curve and persist with their Systematic plans with minor modifications to make sustainable returns on their investments.