What is the Yield Curve? Understanding Interest Rate Term Structure

The yield curve plots the interest rates of bonds with equal credit quality but differing maturity dates. It is a primary indicator of economic sentiment.

A Yield Curve is a line that plots the interest rates (yields) of bonds having equal credit quality but differing maturity dates. In a healthy economy, the curve is upward sloping because investors demand higher yields to compensate for the risk of lending money for longer periods. The most watched curve in global finance is the U.S. Treasury yield curve, which compares maturities ranging from 1-month T-bills to 30-year bonds.

The shape of the curve provides insight into future interest rate changes and economic activity. A normal curve indicates economic expansion. An inverted yield curve, where short-term rates are higher than long-term rates, has preceded every U.S. recession since 1955. For example, in 2023, the 2-year Treasury yield significantly exceeded the 10-year yield, signaling market expectations of an economic slowdown and future rate cuts by the Federal Reserve.

1. Parallel Shift: All maturities move up or down by the same number of basis points (bps). 2. Flattening: The gap between short-term and long-term rates narrows. This often happens when the Fed raises rates to cool inflation. 3. Steepening: The gap between short-term and long-term rates widens, usually indicating expectations of rising inflation and stronger growth.