What is the Yield Curve? A Simple Guide

The yield curve is a line plotting the yields of bonds of the same quality across different maturities, from short-term to long-term. Its shape reveals what markets expect for interest rates and the economy. A normal upward-sloping curve is typical; an inverted one can warn of a downturn.

By plotting bond yields from short to long maturities, you get a curve whose shape carries a message about the economy. Few charts are watched as closely.

This guide explains what the yield curve is and what its shape can tell you.

Key Takeaways

• The yield curve plots yields across different maturities.
• It uses bonds of the same quality, like government bonds.
• Its shape reveals expectations for rates and growth.
• An upward slope is normal.
• An inverted curve can warn of a downturn.

What is the yield curve?

The yield curve is a line that plots the yields of bonds with the same credit quality but different maturities, from short-term to long-term. Usually government bonds are used. The curve shows how the return changes as you lend for longer, and its overall shape carries information about the economy.

What is a normal yield curve?

A normal curve slopes upward, with longer-term bonds yielding more than short-term ones. This makes sense: lending for longer carries more uncertainty, so investors demand a higher return. An upward-sloping curve generally reflects a healthy economy with expectations of steady growth.

Why does the shape matter?

The shape reflects what markets expect for interest rates and growth. A steep curve can signal expectations of rising growth and rates. A flat curve suggests uncertainty. An inverted curve, where short-term yields exceed long-term ones, has often preceded economic slowdowns, which is why it draws so much attention.

How do investors use it?

Investors and economists read the yield curve as a forward-looking gauge. Its changes can hint at where rates and the economy are heading, informing decisions across markets. While no single indicator is certain, the yield curve is one of the most closely followed signals of economic expectations.

What causes the yield curve to change shape?

The yield curve's shape reflects expectations for growth, inflation and interest rates. When investors expect a healthy economy with gradually rising rates, longer bonds yield more than shorter ones, giving an upward slope. When they expect the central bank to cut rates because growth is slowing, long-term yields can fall toward or below short-term ones, flattening or inverting the curve. Because it distils these expectations into one picture, the curve is watched as a barometer of the economic outlook.

How does the yield curve affect banks?

The shape of the yield curve matters greatly for banks, which typically borrow short-term and lend long-term. A steep, upward-sloping curve lets them borrow cheaply and lend at higher long-term rates, supporting their profits. A flat or inverted curve squeezes this margin, making lending less profitable and sometimes discouraging it. Because bank lending fuels the wider economy, the yield curve's influence on banks is one channel through which it affects growth and markets.

Economic data, policy and rates change over time and affect markets in complex ways. This article is educational, uses figures for illustration only, and does not constitute investment advice.

Frequently Asked Questions