This has been the discussion of many investors. However, in my discussions with my Wall Street counterparts (Fixed Income traders in particular), they have not be concerned by the inversion of the yield curve whatsoever.

The yield curve exhibits the expected return on a fixed income instrument (i.e. bonds) for the risk that an investor has to take on when purchasing the product. Typically, if you are surrendering your money for a longer period of time, it involves more risk and you would, therefore, expect a higher return. One of the underlying risks of investing in the long term is inflation expectations. If you are investing long-term, you might be worried that when it is time to cash out your bond 10 yrs from now, inflation could have outpaced your returns. This is why long-term instuments typically have higher yields.

However, when the economy is booming and the Fed is increasing rates agressively to control inflation (because that is their primary objective), investors are less concerned about inflation of the economy in the longer term. Hence, long-term rates begin to drop and inversion begins to occur when the market is speculative of the current (short-term) economic conditions. Investors, as we know, have been tip-toeing around the markets in fear of housing bubbles, deficits, and currency exchange rates.

Hope this helps! Cool stuff!
-Chris-

Welcome to Consumerism Commentary, this week’s host of the Carnival of Investing! The Carnival of Investing is a new Blog Carnival that collects the best blog entries in the past week or so that focus on the topic of investing. In the words of Mr…

For those who don’t know what a basis point is, 100 Basis Points = 1 Percentage Point. In other words, 1 basis point is .01%.

Also, take a look at Barry’s similar article from the finance blog, The Big Picture:
http://bigpicture.typepad.com/comments/2005/12/inverted_yield_.html

Barry is a chief market strategist at The Maxim Group, and cites WSJ frequently as he does in this article.