A yield curve is a line graph that compares the interest rates of bonds from the same issuer across different lengths of time. Usually, lending money for a decade pays a higher annual return than lending for a few months. When the line flips upside down, it shows that investors expect central banks to cut rates in the future.
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The yield curve is a line that compares bond yields for different maturity dates at one moment. It shows short-term and long-term borrowing side by side. Yields on Treasury securities can be plotted for a three-month bill, a two-year note, and a ten-year note. Each point shows what investors demand to lend until that date.
An upward curve has higher yields at longer maturities. A flat curve has similar yields, and an inverted curve has higher short-term yields.
A longer-term yield partly reflects the average short-term rates investors expect in the years ahead. If they expect short rates to fall, long yields may sit below today's short yield. Long yields also include a term premium, extra compensation investors may want for holding interest-rate risk for longer.
Either part can move. The curve can change because investors revise their rate forecasts, demand different compensation for risk, or both.
The U.S. yield curve has often inverted before recessions. That pattern can emerge when investors expect the Federal Reserve to cut short-term rates as the economy weakens.
An inversion is useful evidence about what markets expect, but it cannot tell you whether a recession will happen or give you a date.
A typical yield curve slopes upward. Investors usually demand a higher return, called a term premium or risk premium, when locking up money for longer periods where uncertainty is higher. Long-term yields also incorporate what the market expects short-term rates to average over the coming years.
When investors anticipate that short-term interest rates will drop, long-term yields fall. If they drop below current short-term rates, the curve becomes inverted. Institutional supply and demand also shifts the line: if pension funds buy large amounts of long bonds to meet future obligations, long yields fall regardless of economic forecasts.
Economists monitor the curve by calculating the term spread, which is the difference between two benchmark maturities. A common convention used by the Federal Reserve is the 10-year Treasury yield minus the 3-month Treasury bill rate, though the 10-year minus 2-year spread is also common.
Curves exist for various issuers and currencies. Government curves set a baseline for low-risk sovereign debt, while banks and corporations trade on swap curves and corporate bond curves. Corporate yields sit higher than government bonds to account for credit risk, adding a credit spread on top of benchmark rates.
Does a normal yield curve feature higher yields at longer maturities?
Yes, investors demand more for long risk. A normal upward-sloping yield curve offers higher yields on long-term debt to compensate investors for tying up capital and taking on interest-rate risk over time.
What does an inverted yield curve typically imply about future interest rates?
Investors expect short-term rates to fall. An inversion often occurs when markets expect the central bank to cut short-term rates in the future, driving long-term yields below current short-term yields.
What does a yield curve compare?
Bond yields across different maturities. A yield curve lines up rates for debt that comes due at different times, from short maturities to long ones.
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A parallel shift happens when interest rates across every maturity rise or fall by the same amount. The entire curve moves upward or downward on the chart without changing its overall slope.
No. Through much of the 19th and early 20th centuries, the U.S. economy experienced persistent deflation, which caused the yield curve to spend long periods inverted.
A corporate credit spread is the extra interest rate a company pays above a baseline rate, such as a swap curve. It compensates lenders for the risk that the company might default.
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The national debt is not one giant bill. It is a schedule of IOUs, with old ones coming due while Treasury sells new ones.
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