The U.S Federal Reserve (the Fed) has four tools it uses to directly influence short-term and, indirectly, long-term rate as well. They are:

  1. Open Market Operations: The Fed buys Treasuries or adds funds to the system; this reduces short-term rates. The Fed also sells Treasuries or takes funds out of the system to increase short-term rates.
  2. The Discount Rate: This is the rate at which banks can borrow on a collateralized basis at the Fed's discount window. If the Fed raises rates, they makes it more costly for the banks to do business, which drains cash from the system. If the Fed eases this rate, banks will find it cheaper to borrow additional funds, which will add cash to the system.
  3. Bank Reserve Requirements: This is hardly used these days. If the Fed raises these requirements, money is kept out of the economy. If they lower the rate, additional money will hit the economy.
  4. Verbal persuasion to influence how bankers supply credit to businesses and consumers: This simple method requires no additional explanation.

What is a Yield Curve?
A yield curve represents the relationship between maturity and yields. As an example:

1 Month 1.00%
3 Month 1.25%
6 Month 1.50%
1 Year 1.75%
2 Year 2.00%
5 Year 2.35%
10 Year 2.68%
30 Year 3.00%

If you were to graph this data you would see the yield curve develop. This date is only good for one single point in time because rates are constantly moving. If you are searching for a point on the yield curve that does not have a maturity represented by an actual "on the run security", that point will only be an approximation.

Yield Curve Shapes
Yield Curves come in three shapes:

  1. Upward or Normal Yield Curve: This curve occurs when short-term rates are lower than long-term rates, as noted in the above example.



  1. Inverted Yield Curve: This curve is formed when short-term rates are higher than the longer part of the curve.



  1. Flat Yield Curve: This curve occurs when there is little or no change between short-term and long-term rates.



The Term Structure of Interest Rates

Related Articles
  1. Investing

    Trade Bond ETFs Using Yield Curves

    Different types of yield curves provide important insights for trading bond-based securities.
  2. Investing

    The Impact Of An Inverted Yield Curve

    Find out what happens when short-term interest rates exceed long-term rates.
  3. Markets

    Will an Inverted Yield Curve Happen Again?

    Explore the causes of inverted yield curves, their frequency, their accuracy in forecasting recessions and whether this type of event can happen again.
  4. Investing

    Understanding the Inverted Yield Curve

    An inverted yield curve occurs during the rare times when short-term interest rates are higher than long-term interest rates.
  5. Markets

    Understanding Term Structure of Interest Rates

    The term structure of interest rates is a common method of valuing bonds.
  6. Markets

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  7. Investing

    Yield Curve

    Learn more about how this curve is used to predict changes in economic output and growth.
  8. Markets

    What Is Supply?

    Supply is the amount of goods a producer is willing to produce at a given price, and is one of the most basic concepts in economics.
  9. Markets

    What is a Bell Curve?

    The bell curve is the most common type of graphed data distribution.
  10. Managing Wealth

    How Bond Market Pricing Works

    Learn the basic rules that govern how bond prices are determined.
Trading Center