Yield Curves
The yield curve plots bond yields across maturities. Learn normal, flat and inverted curves, what drives them and why inversions have signalled recessions.
The yield curve is a line plotting the yields of bonds with the same credit quality, usually government bonds, across different maturities, from a few months to 30 years. Its shape summarises what markets expect for interest rates, inflation and growth. Traders watch it to gauge monetary policy, price bonds and loans, and anticipate recessions. The US Treasury yield curve is the most closely watched curve in the world.
Curve shapes#
| Shape | Description | Typical meaning |
|---|---|---|
| Normal (upward sloping) | Long yields above short yields | Expected growth; compensation for holding longer bonds |
| Flat | Similar yields across maturities | Transition; policy tightening late in a cycle |
| Inverted | Short yields above long yields | Markets expect rate cuts, often due to slowing growth |
| Humped | Middle maturities highest | Mixed expectations |
What drives the curve#
- Short end: anchored by the central bank's policy rate. See The Federal Reserve and the FOMC.
- Long end: reflects expected future short rates plus a term premium for the risk of holding long bonds, along with inflation expectations and supply and demand.
long yield ≈ average expected future short rates + term premiumMeasuring the slope#
| Spread | Definition | Notes |
|---|---|---|
| 2s10s | 10 year yield minus 2 year yield | Most quoted by markets |
| 3m10y | 10 year yield minus 3 month bill | Favoured in Federal Reserve research |
| 5s30s | 30 year minus 5 year | Long end slope |
Inversions and recessions#
An inverted curve, especially the 3 month to 10 year spread, has preceded every US recession since the late 1960s, usually by 6 to 24 months, with one widely cited false signal in the mid 1960s. Research by economists at the Federal Reserve Bank of New York, including Arturo Estrella, turned this into a recession probability model.
Inversions appeared before the 2001 and 2008 recessions and before the short 2020 recession. In 2022, the 2s10s curve inverted and remained inverted for over two years, the longest stretch in decades, and did not quickly produce a recession, which led to debate about whether the signal had weakened. See Recession Indicators.
Curve movements#
| Movement | Description |
|---|---|
| Parallel shift | All yields move by the same amount |
| Bull steepening | Short yields fall more than long yields (often as rate cuts begin) |
| Bear steepening | Long yields rise more than short yields (inflation or supply worries) |
| Bull flattening | Long yields fall more than short yields (growth fears) |
| Bear flattening | Short yields rise more than long yields (rate hikes) |
"Bull" means yields falling (prices rising); "bear" means yields rising.
Why the curve matters#
- Bank profits: banks borrow short and lend long, so a steep curve helps them.
- Mortgage rates follow longer Treasury yields.
- Valuations: discount rates for stocks and other assets come from the curve.
- Pricing: bonds, swaps and loans are priced off curves. See Interest Rate Swaps.
Real yields and breakevens#
The nominal curve can be split into a real yield curve, from inflation protected bonds such as TIPS, and a breakeven inflation curve, the difference between the two. A rise in long nominal yields driven by real yields signals tighter financial conditions; one driven by breakevens signals rising inflation expectations. Separating the two helps traders understand why the curve is moving. See Inflation.
Frequently asked questions#
What is the yield curve?#
A line showing yields on bonds of the same credit quality across different maturities, typically US Treasuries from 3 months to 30 years.
What does an inverted yield curve mean?#
Short term yields are higher than long term yields, usually because markets expect future rate cuts, and it has often preceded recessions.
What is the 2s10s spread?#
The difference between the 10 year and 2 year Treasury yields, a common measure of the yield curve's slope.
Next, learn to trade the curve in Yield Curve Trades: Steepeners, Flatteners and Butterflies.
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