A flat yield curve is a yield curve on which short-dated and long-dated bonds from the same issuer offer roughly the same yield, so the line drawn across maturities is close to horizontal. It is usually measured with government debt, and in the United States most often with the gap between the 2-year and 10-year Treasury yields. Traders, bank treasurers, economists and central banks follow it closely.
A flat curve is often a transition. It tends to appear when a normal yield curve is turning into an inverted yield curve, or when an inverted curve is recovering. It differs from a steep yield curve, where long yields sit well above short ones, and it rarely stays flat along its whole length; a curve can be flat in one section and humped or sloped in another.
Flat yield curve in plain terms
Picture a bakery that normally charges more per loaf for a year-long bread subscription than for a single loaf, because it is promising to hold its price for a long time. One day the two prices end up almost the same. Either the bakery thinks flour will soon get cheaper, or customers have stopped worrying about what next year might bring, or both.
A flat yield curve sends a similar message. Normally, lending money for ten years earns noticeably more than lending for two. When the two pay about the same, the market is saying that it expects interest rates to stop rising, or to fall later, and that the extra reward for lending long has shrunk. People read it as a pause: the economy may be near a turning point, and nobody is sure which way it will go next.
Why curves flatten
- Rising short rates. When a central bank raises its policy rate, such as the federal funds rate, short yields climb quickly. If long yields rise less, the curve flattens. This is called a bear flattener.
- Falling long rates. If investors expect slower growth or lower inflation, long yields fall while short yields hold steady. This is a bull flattener.
- A smaller term premium. When the extra return demanded for holding long bonds, the term premium, shrinks, long yields drift down toward short ones.
- Strong demand for long bonds. Pension funds, foreign reserve managers and central bank purchases under quantitative easing can push long yields lower.
Measuring flatness: the 2s10s spread
The most quoted measure of slope is the 2s10s spread, usually expressed in basis points:
- is the 10-year government bond yield, in percent.
- is the 2-year government bond yield, in percent.
- Multiplying by 100 converts percentage points into basis points.
If the 10-year Treasury note yields 4.10% and the 2-year note yields 4.05%, the spread is basis points. A spread within a few tens of basis points of zero is generally described as flat; a negative figure means the curve has inverted. Other measures, such as the 10-year minus 3-month spread, can give a different reading on the same day. Analysts also watch the 5-year to 30-year spread, which covers the long end, so a curve can look flat on one measure and gently sloped on another. Daily figures for all of these come from the US Treasury's published par yield curve.
Flat curves in practice
In the United States the Federal Reserve raised its target rate from 1% in June 2004 to 5.25% by June 2006, yet long yields barely moved. Chair Alan Greenspan called this a "conundrum" in February 2005, by late 2005 the curve was nearly flat, and it inverted during 2006, ahead of the 2008 financial crisis. The curve flattened again during the rate rises of 2017 and 2018 before inverting in 2019. In 2022 rapid rate increases flattened it within months and then inverted it in July of that year.
A flat curve does not by itself predict a recession, and it can persist for long periods when inflation and growth are both stable, or when central bank bond buying holds long yields down. Research by the Federal Reserve Bank of New York links recession risk to an inverted curve, and a flat curve is better read as a warning that the economy may be close to a turning point.
Effects on banks and borrowers
Banks earn part of their income from maturity transformation, paying short-term rates on deposits and earning long-term rates on loans. A flat curve squeezes that margin, which can make lenders more cautious. For borrowers, a flat curve narrows the cost difference between short-term and fixed long-term loans, so fixing a rate for longer becomes relatively cheaper. Investors who normally earn extra by buying longer bonds get little reward for the added interest rate risk, and many shift toward shorter maturities while the curve stays flat.