The US bond yield curve has inverted. Here’s what it means

Investors are often motivated by short-term market players when making decisions.

Shorter-dated bonds are highly sensitive to the Federal Reserve policies than longer-dated bonds. However, longer-term bonds are more sensitive to inflation expectations in the economy as inflation eats into the purchasing power of a bond’s future performance.

In very simple terms, the higher the current rate of inflation and the higher the expected rate of inflation in the future, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk.

When Fed starts to raise rates, signaling a stronger economy, that pushes up yields as investors sometimes tend to get rid of shorter-term bonds and move into riskier assets. However, when investors see inflation expectations for the longer-term stable, as is the case with the U.S. economy currently, they tend to move into longer-term safe-haven bonds, even though they may offer modest yields.

The latest inversion between the three-month and 10-year bond yields was a result of several factors such as Fed’s dovish signal over rate hikes in 2019 and a whole set of disappointing data in Europe, along with the uncertainty surrounding Britain’s exit from the European Union.

On Friday, Germany’s 10-year government bond yields slipped into negative territory on Friday for the first time since October 2016. German government 10-year bond, an important benchmark for European fixed income assets, is viewed as a safe-haven for investors. In times of uncertainty and challenging market environment, investors tend to move their investments from riskier assets into safe-havens like gold and German government bonds. The bond yields hitting negative territory shows there is a rising demand for the 10-year paper due to the ongoing uncertainty in the euro zone economy being fueled from a slowdown in Germany, a deadlock among politicians on Brexit among others.