In his great blog Pete Wargent suggests interest rates may fall to around 2.50% in July 2013 and he cites the ASX futures yield curve.
That would be the equivalent of interest rates being cut four times in the next year.
What yield curves are
Yield curves are not a prediction of the future, rather they are a reflection of yields or interest rates across different contract periods for a similar debt contract.
Where the yield curve is inverted, this reflects that long term investors expect the economic outlook to slow or decline (meaning that interest rates will fall as central banks attempt to stimulate the economy), so they will accept lower interest returns today.
The nerdy stuff
Normally, a yield curve is shaped asymptotically – that is, it curves upwards (the longer the maturity term on the debt, the higher the yield is). The curve generally then flattens out the further to to the right (into the future) the graph progresses as yields top out.
The increased yield for longer term debt reflects that over a longer time period there is an increased possibility of a catastrophic event leading to default, and thus the investor (lender) demands a higher rate of return for the assumed risk.
The inverted yield curve occurs when long-term yields fall below short-term yields, which might reflect a period of fear in the market of interest rates dropping.
When the wealthy are fearful and risk-averse, and see the safest place for their funds as lending to government treasuries for the long-term, the increased demand for these products drives down long-term yields too.
Source: Peter Wargent’s blog
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