The yield curve is one of the most and best used instruments in the global macro investors arsenal. The yield curve is usually thought of as a bond traders tool but good global macro trader know better. You can use the yield curve to trade bonds, stocks, currencies, and really just about anything that affects the economy, heck you can even use to for refinancing your home.

While there are may types of yield curves the most commonly used and most applicable is that of the Treasury yield curve. All you need to do to make a yield curve is to obtain the yield on different Treasury maturities. Get the ninety day, two year, five year, ten year, and the thirty year yields and you will be able to plot them out and see the shape and levels of the yield curve.

This is great but how do you use it to make money? Well the global macro investor knows that if the curve is sloped from the lower left to the upper right that things are looking good for the economy. If on the other hand it is sloping downwards the Fed has tightened and the economy is or will be slowing.

You may be asking yourself why this is. The reasons are actually fairly simple and straightforward. If the curve is steep, meaning the short term rates are low and the long term rates are high it means that banks are lending as they are able to borrow short term from the Fed and charge long term rates to their customers. Obviously when business is good for the banks, they will be lending as much as they can. This in turn spurs new business spending as money is available.

On the other hand if we have an inverted yield curve, where it slopes from the upper left to the lower bottom then banks will not lend as they are borrowing money at more expensive prices then they can loan it out for. This obviously curtails the credit markets and slams a break down on the economy. When this happens the Fed inevitably has to come in and lower rates to bring things back in line and help the economy grow again.

Bonds are like a lever. When bonds are high yields are low. When yields are low bonds are high. It is like a board on a fulcrum, when one end goes up the other end goes down. This is how bonds and rates are related.

If this is the case then anytime you can forecast the yield curve to show when the Fed will be lowering rates you can jump on it and go long bonds, typically with little risk. At the same time whenever you see rates being lowered you can wait a while and then go long stocks.

Neither of these relationships works perfect every time so it is important to still use risk controls. In fact if you had gone long stocks in 2008 when they lowered rates you would have lost a lot of money, but more often then not this trade and the concept behind it work well. Look at the yield curve, learn from it, and apply it to your market forecasting toolbox.