The dominant economic stories of the past few weeks pertain to the rising rate of inflation, the Fed's efforts to control inflation, the war in Ukraine, the price of commodities (especially oil) and the yield curve. These stories are big, long, complicated and extremely important. They affect every American household and business, especially the businesses that comprise the plastics industry.
It will take a long time before anybody garners a deep understanding of these stories, but for this column I will to attempt to shed a little more light on the discussion of the yield curve.
On the chart I have graphed two yield curves: one from April 1, 2022, and one from exactly one year earlier, April 1, 2021. A yield curve is a snapshot on a given day showing the percentage yields, or interest rates, the purchaser of the underlying Treasury bond or note will be paid at maturity. The yield curve changes a little bit every day. When compared with last year, the yield curve has changed shape and shifted upward. This data is posted daily at treasury.gov.
The U.S. government is a huge borrower, and it borrows funds (sell Treasurys) with a wide range of maturities. There is a highly liquid secondary market for these instruments, and that is why the yield curve constantly changes. You can buy any of these instruments any day the market is open and then sell it anytime thereafter.
The thing to keep in mind is that their respective prices fluctuate constantly depending on what the market collectively believes about the outlook for the economic conditions in the U.S. The actual yield a holder at maturity receives will depend on how much they paid for the bond or note at the time they purchased it. These two curves indicate the yields one would be paid if they made a purchase on April 1 of either this year or last year.
For the sake of simplicity, I will state that interest rates (and yield curves) are primarily affected by two closely related things: the market forces of supply and demand for these Treasurys; and the Fed Funds Rate, which is the short-term rate the Fed charges banks to borrow money. Once the market gets close to equilibrium with these levels, then interest rates for things such as mortgages, auto loans, savings accounts and credit cards are set.
There is a long-established tradition of trying to forecast future economic trends based on the shape and the slope of the yield curve. I believe near-term historical yield curves are useful for understanding present economic conditions. They can even flash warning signs about the changing probabilities of future outcomes. But they should not be relied upon too heavily. They should be monitored, but they are only a part of a comprehensive forecasting model.