Decoding the Yield Curve Shapes 

The journey towards Intermarket Analysis leads us to delve deeper and deeper into the world of interest rates. In the last article, we saw the mathematics of a yield curve. Extremely simple, where it becomes very clear how interest rates are generated, what they are composed of, and how their terms form completely different assets. Decoding the Yield Curve is  foundational for trading—no matter the asset.

We know that

nominal = real + inflation + Term Premium

We understand that there is a yield curve for any country, company, or individual that can issue debt at different maturities. All we need is for this entity to be the same and have different maturities.

1 Decoding the Yield Curve 

The American yield curve is the most well-known for being considered risk-free, given that it is American Treasury debt issued in dollars. If we were to be strict, it still has the risk of the dollar’s value, but being the world’s reserve currency, it seems that this risk does not apply. False. But we will only get to this at the end of the intermarket journey.

2 Decoding the Yield Curve: Yield curves of different countries

Before we dive into the messages these curves convey, it’s good to understand some key points.

• No company, Individual, can borrow at an interest rate lower than that of the country where the debt is issued. There is a spread between national debt and the extra risk, which any economic agent adds. It can be thought of as systemic or macro risk, plus the micro risk that each market player adds. 
• Central banks have control over short-term interest rates. Except in exceptional situations, they directly influence them and thereby influence those that follow in maturities. As we will see in the upcoming articles, this influence fades over time. As rates increase in term, the effect that short-term rates have on them decreases. 
• Each asset responds differently to changes in the interest rate. This depends on their flow of rates and the duration of these flows.

3 Decoding the Yield curve: Interpreting a Normal Yield Curve

Why does the shape of a yield curve change? What implicit messages does it have? Why is the speed of the changes crucial?

Let’s see.

In every shift of the yield curve, the question to ask is: What is actually moving?

Is it the real rate? Inflation expectations? The term premium investors demand?

The answer clarifies the market’s expectations for the economy across different time horizons.

Every yield curve movement has bullish or bearish origins—or a combination of both—driven by the components of interest rates.

 If the market  expects a healthy economy. There is an expansive monetary policy, reflected in the low short-term interest rates.

This will generate, according to the market interpretation at that time, economic growth and future inflation. 

Therefore, a higher return is demanded to invest at that maturity. The market is visualizing a growing economy. Esto se conoce como un bull steepened. 

4 Decoding the Yield Curve: Bear steepening

A steepening driven by a sharp rise in the long end of the curve could also reflect higher inflation expectations or increased perceived risk. That’s why it’s crucial to understand what’s happening in the broader economy.

The term premium and the preference for liquidity also drive long-term yields upwards. Expecting higher inflation, higher nominal rates are demanded so that the real rate of return is not affected. 

This information obtained in the bond market, obviously affects the stock markets. Stocks, a specific category of stocks, currencies, and commodities. Everything will be affected by these expectations.

5 Decoding the Yield Curve: Understanding a Flat Yield Curve

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