What Yield Curves Are Telling Us Today

Tim Strauts: In today's chart, we are going to look at government-bond yield curves for the United States, Germany, Japan, and the United Kingdom. Before we discuss each country, let's review how the chart is constructed. A yield curve is a line that plots the interest rate available at different bond maturities. In this chart, the range of maturities is one month to 30 years.

The shape of the yield curve can tell us a lot about future interest-rate changes and economic activity. A normal yield curve is upward sloping to the right, signifying that an investor gets higher yields for taking the risk of a long-dated security. You see this type of yield curve most of the time. Right now, the U.S. has the strongest economy in the world and, as you can see, the U.S. yield curve is the only one that is normal. The U.S. has low unemployment, positive economic growth, and the Federal Reserve raised interest rates just a few months ago.

On the other hand, an inverted yield curve is one where shorter-term yields are higher than longer-term yields. You typically see this type of curve before recessions. While no country on the chart has a fully inverted yield curve, the United Kingdom and Japan are partially inverted. In these two countries, the shortest-term interest rate is higher than the rates one to two years out. This signifies that the market believes that the central banks of these countries will lower short-term interest rates in the near future.

Finally, Germany has an upward-sloping yield curve--just like the United States--but its curve has negative yields for bonds less than eight years to maturity. German government bonds are considered the safest euro-denominated debt, which has pushed their interest rates to extremely low levels. Last week, Mario Draghi, the president of the European Central Bank, lowered its deposit rate and expanded its asset-purchasing program with the goal of increasing inflation and economic growth. This will only put more downward pressure on German yields. It remains to be seen what the effect of maintaining persistently negative interest rates will be.

In conclusion, watching the yield curve can be a good way to monitor the economy and can be used to predict future short-term interest rates.