“The shift from an upward-sloping yield curve to a downward-sloping yield curve is sending a warning about a possible recession.” The statement means that the yields derived from the bonds with shorter durations yield higher than the relationships that are invested for a longer duration of time. The downward-sloping yield curve indicates declining rates of interests that are caused by reduced economic activities in a country and leads to the negative growth of the economy. The normal yield curve is said to be inverted because the short- term bills yield less than the long-term bonds. The inversion of the curve is mainly attributed by the investors losing confidence with the economy and therefore shifting from long-term to short-term to get more yield. In the inverted yield curve, the investors perceive investing in bonds to be less risky compared to long-term investment in a deteriorating economy.
Theory about the shape of the yield curve
The Expectation theory (ET) explains the structure of the interest rates in that current long-term bonds relate to the bond market’s expectation about the interest rates of short-term durations. The investors make the market analysis and make partial decisions based on the status of the current economy, which enables them to predict the future levels of interest rates. The declining or negative growth of the economy lowers the investors’ expectations on high yields of the bonds if they invest for long- term durations.
The investors opt to risk with short-term interest rates hence making the Yield curve slope upward while long-term rates proportionally get higher than the short-term rates. Consequently, the decline in short-term rates results in a downward sloping yield curve, which translates into a recession. The economic slump of a country results in falling interest rates. The declining economy forces the investors to shift their money from short-term investments to long-term bonds in fear of making losses. The shift from the short-term securities increases the short –term interest rates and lowers the long- term rates resulting in an inverted yield curve.
Recession results in downward sloping involve the loss of employment to many. According .., recession results in low earnings from most of the organization in the economy. As a means of ensuring continuity in the competitive markets, the firm comes up with mechanisms to reduce expenditure. One of the mechanisms is reducing the number of employees, which in the long run, reduces the productivity of an organization. According to .., recession causes many individuals and families to lose jobs, causing a struggle in settlement of bills. The same author stated that the inability of individuals to find jobs does not only after the family but also economic productivity at large.
The second reason why the anticipated recession causes a move downward is that the charged lifestyle. Notably, during the recession, the population experiences reduced entertainment, extracurricular, and dining activities expenses. Individuals cut down of the extra expenses that are aimed to increased saving during the recession. According to .., drastic changes are experienced in the period pre-recessions that reduced the growth of sales and profits for businesses. Therefore, the economy experiences shares experiences, fewer trips, and missed business opportunities due to lack of funds.
The third reason why there is a downward shift in the yield curve is reduced investment. The individual’s budgets are not able to accommodate the long and short term non-residential investments. Many people opt to put investment accounts on hold, with the aim of increased profits in the future. Additionally, many individuals do not see the value of investing in non-feasible businesses.
Business opportunities are also affected by recession resulting in a downward shift in production. According to .., the entrepreneurs lack money during the recession, which affects their ability to pay bills. The same author established that the lack of funds to the entrepreneurs reduce the innovativeness, which in the long run affect the productivity of a country. Furthermore, the financial institutions that are supported to fund the entrepreneurs are not ready to take the risk during the recession. Therefore, the unemployed entrepreneurs willing to start new business can be affected adversely by recession.
Education is a challenge during the recession as many parent are unable to take their children to colleges. Lack of education affects productivity as the economy is faced by lack of skilled labour. Therefore, the adoption of technology is affected as many people lack the knowhow to facilitate production. Lastly, anticipated recession results in reduced value for real estates. Many individuals people depends on real estates as part of their retirement plan. Recessions results in drastic fall and increased foreclosures forcing many people out of their home.
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