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Bond yield inversion and impact on recession

There is a known finance theory of bond yield inversion and its impact on the upcoming slowdown and recession. We will see on details on this concept in this article.

What are bonds ?

Bonds are different types of fixed income instruments. There are public traded bonded (as listed on stock exchanges like NSE), there are privately traded bonds. Bonds are issued by governments, municipalities and big corporates whenever they want to start a big project, and want to crowd source the money from people. They do this by issuing bonds, and promising an interest rates over fix period of time.

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Important features in bonds

Bonds are purchased by investor at issue price, which is price at which bond is trading currently.

There is always face values attached to bond, this is the amount which investor will get from bond at the end.

There is also maturity period, which is time period offered at the time of period for returning money (face value).

Investor are paid coupon payments at fixed coupon rate at regular interval (most often half yearly).

Bond yield is defined as rate of interest if bonds are held till maturity. This is also known as internal rate of interest(IRR) or Yield to maturity (YTM).

Different types of government bonds

Government issues there types of bonds.

Treasury bill– Time duration less than 1 year

Treasury notes – Time duration between 1 to 10 years

Bonds – Time duration more than 10 years.

Government bonds are more in demand from private players, as govt is offering security on these bonds thus making them well secured.

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What is bond yield inversion

Bond yield inversion happens when yield of short term bond become greater than yield of long term bond. There is widespread insecurity and apprehension in the market, and it has been seen that whenever in last 70 years, short term yield become larger than long term yield, recession happens immediately afterwards. However, there is no time prescribed to recession. It may happen in 0-24 months as seen in previous data.

In recent times(Aug 2019), we have seen that US is seeing bond yield inversion phenomenon.

Economists are saying that the reason for behavior on yield is due to US general trade practices like trade war with China and increasing tariffs from multiple countries.

Conclusion

In this article, we have seen concept of bonds and yield curve inversion, possibilities of its occurrence. If you have any question, feel free to contact us.

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