Loading the player...

What is a 'Yield Curve'

A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is also used to predict changes in economic output and growth.

Yield Curve

BREAKING DOWN 'Yield Curve'

The shape of the yield curve gives an idea of future interest rate changes and economic activity. There are three main types of yield curve shapes: normal, inverted and flat (or humped). A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. In a flat or humped yield curve, the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition.

Normal Yield Curve

A normal or up-sloped yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. When investors expect longer-maturity bond yields to become even higher in the future, many would temporarily park their funds in shorter-term securities in hopes of purchasing longer-term bonds later for higher yields. In a rising interest rate environment, it is risky to have investments tied up in longer-term bonds when their value has yet to decline as a result of higher yields over time. The increasing temporary demand for shorter-term securities pushes their yields even lower, setting in motion a steeper up-sloped normal yield curve.

Inverted Yield Curve

An inverted or down-sloped yield curve suggests yields on longer-term bonds may continue to fall, corresponding to periods of economic recession. When investors expect longer-maturity bond yields to become even lower in the future, many would purchase longer-maturity bonds to lock in yields before they decrease further. The increasing onset of demand for longer-maturity bonds and the lack of demand for shorter-term securities lead to higher prices but lower yields on longer-maturity bonds, and lower prices but higher yields on shorter-term securities, further inverting a down-sloped yield curve.

Flat Yield Curve

A flat yield curve may arise from normal or inverted yield curve, depending on changing economic conditions. When the economy is transitioning from expansion to slower development and even recession, yields on longer-maturity bonds tend to fall and yields on shorter-term securities likely rise, inverting a normal yield curve into a flat yield curve. When the economy is transitioning from recession to recovery and potentially expansion, yields on longer-maturity bonds are set to rise and yields on shorter-maturity securities are sure to fall, tilting an inverted yield curve toward a flat yield curve.

RELATED TERMS
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments ...
  2. Term Structure Of Interest Rates

    The relationship between interest rates or bond yields and different ...
  3. Yield Elbow

    The point on the yield curve indicating the year in which the ...
  4. Normal Yield Curve

    A yield curve in which short-term debt instruments have a lower ...
  5. Flat Yield Curve

    A yield curve in which there is little difference between short-term ...
  6. Yield Curve Risk

    The risk of experiencing an adverse shift in market interest ...
Related Articles
  1. Investing

    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.
  2. Investing

    Trade Bond ETFs Using Yield Curves

    Different types of yield curves provide important insights for trading bond-based securities.
  3. Insights

    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.
  4. Investing

    The Impact Of An Inverted Yield Curve

    Find out what happens when short-term interest rates exceed long-term rates.
  5. 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.
  6. Insights

    Understanding The Treasury Yield Curve Rates

    Treasury yield curves are a leading indicator for the future state of the economy and interest rates.
  7. Investing

    Understanding Term Structure of Interest Rates

    The term structure of interest rates is a common method of valuing bonds.
  8. Investing

    Bond Yield Curve Holds Predictive Powers

    This measure can shed light on future economic activity, inflation levels and interest rates.
  9. Investing

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  10. Investing

    What’s the US Yield Curve Signaling?

    In recent weeks, the difference in yields between 10-year and 2-year U.S. Treasuries has hit post financial crisis lows, as evident in the chart below.
RELATED FAQS
  1. What are the different formations of yield curves?

    Find out more about the yield curve and yield curve formations, what yield curves measure and the three main types of yield ... Read Answer >>
  2. What is the current yield curve and why is it important?

    Understand what the current yield curve represents, and learn how market analysts commonly interpret various changes in the ... Read Answer >>
  3. How can the yield curve help me make investment decisions?

    Learn about the yield curve, and discover why this chart is an important economic indicator. How do Treasury bond yields ... Read Answer >>
  4. What is the difference between term structure and a yield curve?

    Understand the difference between the term structure of interest rates and a yield curve, if any. Learn what the yield curve ... Read Answer >>
  5. What does the yield curve actually predict?

    Find out what an inverted yield curve represents, how it has performed as a leading indicator and why it appears to hold ... Read Answer >>
  6. Why are the term structure of interest rates indicative of future interest rates?

    Learn why economists believe the term structure for interest rates reflects investor expectations for future interest rates ... Read Answer >>
Hot Definitions
  1. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  2. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  3. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  4. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  5. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  6. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
Trading Center