What is a Yield Elbow
A yield elbow is the point on the yield curve indicating the year in which the economy experienced the highest interest rates. The yield curve is the graphical relationship between the yield and maturity of bonds with different maturities and equal credit quality, at a specific point in time.
BREAKING DOWN Yield Elbow
The yield elbow is the highest point of the yield curve, signifying where the highest interest rates occurred.
A yield curve involves a particular, individual type of bond. The graph is an illustration in which the yields of these similar-quality bonds are plotted against their yields, along the spectrum from shortest to longest. This can show how short-term yields compare to longer-term yields.
Yield curves play an important role in the pricing of bonds. Investors and analysts reference yield curves to identify opportunities for realizing high rates of return on certain investments.
The yield elbow typically occurs when there are concerns about current or future inflation, and can correspond to low prices for bonds. Predicting a yield elbow can be challenging, since yield curves are constantly changing, and can fluctuate due to a variety of factors that may be difficult to anticipate.
Yield Elbow and Types of Yield Curves
One of the most commonly reference yield curves compares U.S. Treasury bonds with a three-month, two-year, five-year, and 30-year maturity term.
Three main types of yield curves exist, including normal, inverted and flat. A normal curve is one where longer maturity bonds have a greater yield compared with shorter-term bonds because of the risks associated with time. This is sometimes also referred to as a “positive” yield curve.
An inverted yield curve indicates an interest rate environment where the shorter-term yields are higher than the longer-term yields, which is a possible indicator of an upcoming recession. This type of curve can also be called a “negative” yield curve.
A flat yield curve happens when the shorter- and longer-term yields are close, indicating a potential economic transition.
On any type of curve, the yield elbow is the highest point. Economists cite the Federal Reserve as having a strong influence on the yield curve. When the Federal Reserve raises interest rates, investors tend to become more confident about inflation being kept under control for the most part, which means investors feel more secure about longer-term maturities. If the yield curve remains relatively flat even though the economy seems to be booming, this can signal that investors are not confident the positive trend will last long.