Yield Curve

What Is a Yield Curve?

A yield curve is a line chart that shows the yield on government bonds across a range of maturity dates, from short-term bills to long-term bonds. The horizontal axis shows time until maturity, and the vertical axis shows the annual yield. Analysts usually build the curve from U.S. Treasury securities, since they are considered very low in default risk, which lets the shape reflect expectations about interest rates rather than differences in credit quality.

How It Works

Each point on the curve represents the yield an investor would earn by lending money for a specific length of time. Because investors usually demand more compensation for tying up money longer, the curve normally slopes upward. Its shape also reflects expectations for future interest rates and inflation, as well as the federal funds rate set by the central bank.

The curve can take several common shapes:

• Normal: long-term yields are higher than short-term yields, which is the typical pattern.
• Flat: short- and long-term yields are close to each other, often during transitions in the economy.
• Inverted: short-term yields are higher than long-term yields, which is less common and has historically preceded economic slowdowns in many cases.

Why It Matters to Investors

Investors watch the yield curve for clues about the economy and about how bond prices might move. Its shape influences borrowing costs for mortgages, business loans, and other debt, and it is used as a reference point when pricing many financial products. A steep curve can suggest expectations of stronger growth, while an inverted curve is often treated as a warning sign, though it is not a guaranteed predictor of recession.

The yield curve is a snapshot of market expectations, not a forecast on its own. Investors use it to compare returns across maturities and to understand how their bond holdings might be affected by changes in interest rates.