The Yield Curve
Connect the yields of Treasuries at different maturities into a line: normal and upward-sloping, flat, or inverted? It's often seen as a barometer for the economy.
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Text version · Bonds & Fixed Income, lesson 6: “The Yield Curve”
Connect the yields of Treasuries at different maturities into a line: normal and upward-sloping, flat, or inverted? It's often seen as a barometer for the economy.
One line, three shapes
Connect the yields of Treasuries from 3 months to 30 years and you get the yield curve. Normally it slopes upward; when the short end is higher than the long end, it's a yield curve inversion.
The central bank steers the short end, expectations steer the long end
Raising the policy rate pushes up short-term yields first; long-term yields depend more on what the market thinks about future growth and inflation.
Inverted: the market is betting on rate cuts
The extra piece at the long end in a normal curve is the term premium. An inversion means the market expects the economy to weaken and the central bank to cut rates later, so long-term rates end up lower. It often shows up before recessions, but not always.
Key takeaways
- Normal curve: the longer the maturity, the higher the yield. The extra is the term premium (compensation for time and interest rate risk).
- Inversion: short-term yields above long-term yields, meaning the market expects rate cuts ahead. It's often read as a sign of a slowing economy (but not always).
- Central bank rate hikes mainly lift the short end; market expectations for long-term growth and inflation drive the long end.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Example: 2-yr 5% · 10-yr 4%”: what shape does the badge say this curve is?
- Go back to “Normal” and click “Central bank hikes +1%” twice: which end rises most? What shape does the curve take?
- Then click “Economic outlook weakens”: what happens at the long end? What does the spread on the “10Y − 2Y” card become?
- Drag the 10-year point on the chart below the 2-year point: at what moment does the badge switch to inverted?
Quiz and explanations
- 1. The 2-year yields 5% and the 10-year yields 4%. This curve is…
- Answer: Inverted.The short end is above the long end, so it's inverted.
- 2. The central bank hikes rates sharply. What gets pushed up most directly?
- Answer: Short-term yields.The policy rate hits the short end first.
- 3. The 3-month Treasury yields 5.3% and the 10-year Treasury 4.2%. What's the "10-year − 3-month" spread, and what shape is the curve?
- Answer: −1.1%, inverted.4.2% − 5.3% = −1.1%. The long end is below the short end, so the curve is inverted.
Terms in this lesson
- yield curve inversion (Inversion): Short-term yields rising above long-term yields, often seen as a sign of an economic slowdown.
- policy rate (Policy Rate): The benchmark rate set by a central bank, which drives borrowing costs across the economy.
- term premium (Term Premium): The extra yield investors demand for lending money for longer, as compensation for more interest rate risk.
- yield curve (Yield Curve): The line joining government bond yields across maturities; it can slope up, go flat or invert.