Market feels the force

FIVE-MINUTE GUIDE TO... THE INVERTED YIELD CURVE

- Harvey Jones

SEPTEMBER was a tough month for investors as the US stock market crashed, but the apparent cause may have baffled many as financial analysts blamed it on a mysterious force called the yield curve.

Apparently, this curve has the power to predict the future, in particular whether the economy is heading for a recession, which seems to be the case today.

So what is this oracle and how does it work? The yield curve is a simple line that plots the interest rates paid by bonds running for different periods of time, say, two, five, 10 or 30 years.

Bond yields typically follow a sloping upward curve, as short-dated bonds pay lower rates of interest, which steadily rise for bonds with a longer maturity.

In normal times, a two-year bond may yield, say, 3 per cent, a five-year bond may yield 3.4 per cent and a 10-year bond around 4 per cent. It is the same principle with fixed-rate savings bonds, an everyday savings product sold by banks and building societies. Savers would normally expect a higher rate of interest if they locked their money away for five years, rather than one or two.