Economists and real estate experts are always predicting the "next" recession based on factors such as timing, observation of market patterns and various economic data. There is also a key element factored into such predictions that is known as
the "yield curve."
A yield curve is a representation of changing interest rates as related to government bonds of varying expiration dates. Bonds which expire quickly are known to yield much lower returns than long-term bonds. Investors, for example, are famous for purchasing
long-term bonds as a means of earning a high return on investments over a longer period of time instead of chancing a smaller return off of a short-term investment opportunity.
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When the economy is economically prosperous, the difference between short and long-term bonds and their return rates differ greatly. In addition, bond yields are ever changing which means that the yield curve tends to waiver, too. Supply and demand factors
in as the yield dips when the demand for bonds is greater. While the government does not control bond returns, they do offer higher incentives for longer term bonds. In other words, consumers earn less money for high demand bonds.
Pre-recession conditions cause investors
to grow nervous. Many opt to pull cash from various investments in exchange for long-term financial security by placing that cash into long-term bonds. Many investors consider the stock market and real estate ventures too
risky in less stable markets and opt for safer means of investment. This causes the demand for long-term bonds to rise and the yield to dwindle. Short-term bonds increase in demand as investors dump them for the sake of financial security and those short-term
bonds grow high in demand.
THE BOTTOM LINE:
The yield curve truly is one of the best means of predicting a recession. Experts can easily calculate a recession six to eighteen months in advance using the curve alone. This practice allows for preparation and financial calculation of the cost of a
recession during a specific economy.
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