Yield Curve

The yield curve is a line that plots the interest rates, or yields, on bonds of the same credit quality against their time to maturity. The benchmark curve in most countries uses government bonds, running from short-term bills of one or three months out to long-term bonds of ten or thirty years. Because those securities differ mainly in maturity, the shape of the curve shows how markets price borrowing over different horizons and what they expect for interest rates, inflation and economic growth.

The yield curve is one of the most watched indicators in finance. It is used to price loans and bonds, to value interest rate swaps and other derivatives, to assess bank profitability and to gauge the stance of monetary policy.

A yield curve is built from the yields on a set of bonds with different maturities. In the United States, the Treasury publishes daily yield curve rates derived from Treasury bills, notes and Treasury bonds. Analysts also derive zero-coupon (spot) curves, which give the yield on a single payment at each maturity, and forward curves, which show the rates implied for future periods. Curves can also be built from swap rates or from corporate bonds of a given rating.

Short-term yields are anchored by the central bank's policy rate, such as the federal funds rate in the United States, and by overnight benchmarks like SOFR. Long-term yields depend more on expected future short rates and on the extra compensation investors demand for holding long-dated debt, known as the term premium.

• Normal (upward-sloping): long-term yields are higher than short-term yields, reflecting the term premium and, often, expectations of steady growth.
• Flat: yields are similar across maturities, often during transitions in the economic or policy cycle.
• Inverted: short-term yields exceed long-term yields, usually because markets expect policy rates to fall. An inverted yield curve has preceded most US recessions in recent decades.
• Humped: medium-term yields are higher than both short and long yields.

Commentators often summarize the slope by a spread, such as the difference between ten-year and two-year government yields, measured in basis points.

Economists explain the shape of the yield curve with several theories. The expectations hypothesis holds that long yields are an average of expected future short rates. The liquidity premium theory adds that investors require extra return for tying up money for longer. The market segmentation and preferred habitat theories argue that different investors, such as pension funds and banks, have preferred maturities, so supply and demand in each segment matter. In practice, the curve reflects a mixture of these forces.

Suppose a one-year government bill yields 4.0% and a two-year note yields 4.5%. Under the expectations hypothesis, investors should be indifferent between buying the two-year note and buying two consecutive one-year bills. That implies an expected one-year rate a year from now of roughly 5.0%, because (1.040 × 1.050) is close to (1.045 squared). If the two-year yield were instead 3.5%, the implied future one-year rate would be about 3.0%, signaling expected rate cuts.

Banks typically borrow short and lend long, a process known as maturity transformation, so a steep curve tends to support their net interest margin and a flat or inverted curve squeezes it. Mortgage rates, corporate borrowing costs and the pricing of bonds are all set relative to the government curve. In foreign exchange markets, differences between countries' yield curves influence capital flows and the carry trade.

Central banks influence the curve directly through their policy rate and, at longer maturities, through tools such as quantitative easing and, in a few cases, explicit yield curve control.

The yield curve is an imperfect forecaster. Central bank bond purchases, regulatory demand for safe assets and changes in the term premium can distort its shape and weaken its signal. An inversion indicates market expectations rather than a certainty, and the lag between inversion and any downturn has varied widely.