What is Yield Curve in Forex?

Forex Yield Curve

The interest rate curve rises from left to right because higher annual interest rates reflect an increase in investment risk as the years go by. On this yield curve, if the long-term yield is higher than the short-term yield, the yield curve will be steep. The yield curve refers to a chart of returns for a group of bonds or other financial instruments with the same currency and credit risk but different maturities. The vertical represents returns, while the horizontal represents the time to maturity.

Types of Yield Curves and Their Significance 

There are many different yield curves, such as the benchmark yield curve of government bonds, the yield curve of deposits, the yield curve of interest rate swaps, the yield curve of credit, etc. The reference standard for other Securities in the market is the benchmark yield curve, and the securities used must meet the characteristic standards of liquidity, scale, price, availability, circulation speed, etc.

The yield curve is not static and can change quickly and at any time. For example, the few words spoken by central bank officials may trigger higher inflation expectations, leading to a greater decline in long-term bond prices compared to short-term bonds.

Generally, the yield curve rises from left to right because a higher annual interest rate can better reflect the increase in investment risk with the passage of time. On this yield curve, if the long-term yield is higher than the short-term yield, the yield curve will be steep.

The reverse hanging yield curve declines from left to right, reflecting the abnormal phenomenon that the short-term yield is higher than the long-term yield. Perhaps it is because investors anticipate a decrease in long-term inflation or a significant decrease in bond supply, both of which will lower yields. When it comes to interest rates, financial commentators usually say that interest rates fluctuate up and down, as if every change in interest rates is consistent. In fact, if the maturities of bonds are different, the direction of interest rates will vary, and the trends of long-term and short-term interest rates will diverge. The key lies in the overall shape of the yield curve and its enlightenment on the future trend of the economy or market.

Analyzing Economic Trends Through the Yield Curve 

To find clues about the trend of interest rates from the yield curve, investors and enterprises should pay close attention to its shape. The basis of the yield curve is the yield you get by buying short-term, medium-term, and long-term Treasury bonds of the government. According to the maturity curve from holding bonds to principal recovery, the yields of different bonds can be compared.

The shape of the yield curve is based on the different lines of Treasury bond yield points on the vertical axis as well as the bond's annual maturity point on the horizontal axis. Now you can see that the yield curve above is somewhat steeper, and the yield of annual bonds is almost higher than that of a three-month short-term Treasury bond. In general, the difference between these two types of bonds is close, and if the difference is higher than this percentage, it indicates that the economy is expected to improve in the future.

The sharp rise in yield generally occurs in the early stages of economic growth, closely following the economic recession. During this period, economic stagnation suppressed short-term interest rates, but Yidan's economic activities restored demand for capital and the fear of inflation, leading to a general rise in interest rates.

Traditionally, a reversal curve indicates that the economy is about to slow down. Financial institutions like banks usually borrow at short-term interest rates and borrow for the long term. Generally speaking, when long-term interest rates are higher than short-term interest rates, both are relatively high, and banks usually borrow less funds in this situation. Generally speaking, a decrease in corporate borrowing can lead to a credit squeeze, slow business development, and an economic recession.