What Is a Parallel Shift in the Yield Curve?
Find out more about the yield curve and what a parallel shift in the yield curve means for investors.
What Is a Parallel Shift in the Yield Curve?
The yield curve refers to the relationship between short-term interest rates, intermediate interest rates, and long-term interest rates. When plotted on a graph, these points form a curve, the shape of which depends on the rates and maturities of the debt securities being measured.
A so-called parallel shift in the yield curve happens when the interest rates on all fixed-income maturities—short-term, intermediate, and long-term—increase or decrease by the same number of basis points. Such a change would shift the yield curve parallel to its present location on the graph without affecting its slope.
For example, if 1-year, 5-year, 8-year, 10-year, 15-year, 20-year, and 30-year bonds all increased by 1.5%, or 150 basis points, over their previous level, this would be a parallel shift in the yield curve because the curve itself didn't change. Rather, all data points on it moved in the same direction while the curve itself maintained its prior slope and shape.
How a Parallel Shift in the Yield Curve Works
When the yield curve is upward sloping, which is the majority of the time, long-term rates are higher than short-term rates, due to the increased inflation risk of longer maturities. Parallel shifts are the most common during these normal yield curves.
Inflation risk is the risk that inflation will rise, reducing the value of the payouts of an investment.
When the yield curve is inverted, or sloping downward, it means long-term interest rates are lower than short-term rates. Inverted yield curves can indicate an approaching recession.
Common risks to guard against with these securities include inflation risk, repayment risk, and call risk, which is the risk a callable bond will be called, or rdeemed.
Investors in fixed-income securities must also deal with yield-curve risk, more commonly known as interest rate risk. This is the danger that shifts in the yield curve can cause bond prices to fluctuate substantially.
When investing in bonds, it's important to understand the effect of market rates on bond prices and yields. There's often an inverse relationship between prices and interest rates: when market interest rates rise, bond prices fall, and vice versa. When market interest rates fall and bond prices rise, the yields decrease, because it becomes more expensive to buy the bond and the interest rates are lower.
Interest rate risk can mean huge losses, or years spent in underwater (below-value) positions, if it is not carefully managed. It can be especially disastrous for hedge funds, exchange-traded funds, or private accounts that use leverage to boost fixed-income returns.
What It Means for Individual Investors
For investors who buy bonds and hold them to maturity, parallel shifts in the yield curve aren't meaningful in a practical sense, as they will have no effect on the ultimate cash flow, taxes assessed, and realized capital gains or losses of the held bond.
For those who might liquidate their positions prior to maturity, one way to protect against major changes in interest rates may be to reduce bond duration, as the closer maturity dates often mitigate the volatility.
Another way is to use investment laddering, which is when you buy an assortment of fixed-income investments with different maturity dates, from short-term to long-term. At any given time, you have a maturity coming up, so there's capital there if you need it. If not, you can roll it into a more distant maturity, capturing the (typically) higher yields on longer-term holdings.
Laddering is one of three bond investing strategies that can make a big difference in your overall risk profile, allowing you to build a collection of securities that can return a higher aggregate yield in a shorter duration—ideally giving you the best of both worlds.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
- A parallel shift in the yield curve is when interest rates across all maturities change by the same number of basis points.
- Yield-curve risk, also known as interest-rate risk, is the risk of interest rate changes affecting bond prices.
- A parallel shift in the yield curve neither flattens nor steepens the yield curve. Instead, it indicates an overall change in interest rates.