Expert: Doug Ingram - 2/11/2005

Question
I am just curious of why the interest rate of a middle-term bond are sometime greater than long-term bond's. Isn't the longer the invester holds a bond the higher the interest rate. What is the reason?  

Answer
Like other economic data, it can be supply and demand!  For instance, the U.S. Treasury quit issuing 30-year bonds in 2001.  Since then the 30-year is closing in on the rate of the 10-year.
Over the past 20 years we've had 4 or 5 major inversions in the yield curve.  These have lasted for a few weeks to 18 months (coming into Y2K).  A curve is inverted if short-term rates are higher than long-term rates or even if mid rates are higher than longer-term rates.
One of the major causes is skepticism about future rates.  Right now investors are investing longer becasue they think short term rates will rise.  That leads to the effect you've noted.  The Fed is raising short-term rates, but has little controll over long term!
The problem is also that - when a yield curve gets flat or inverts, it will always eventually return to a curve that is based on inflation and rewarding investors that buy longer term.  So we KNOW that the yield curve will once again maintain a positive slope.
What we don't know is if short rates will fall or if long rates will rise!  That's the dilemma.  So, it's always temporary.
A lot of foreign investors are coming back into the dollar right now.  They know that short rates are going up.  They buy stocks or bonds.  The safest bet is to buy longer-term issues (given that short rates are rising).  That has inverted this curve, but other reasons do that at other times.