Table of Contents

Yield Curve: What It Is and How to Use It

By

Adam Hayes

Updated September 27, 2023

Reviewed by

Gordon Scott

Fact checked by

Suzanne Kvilhaug

What Is a Yield Curve?

A yield curve is a line that plots the yields, or interest rates, of bonds that have equal credit quality but different maturity dates. The slope of the yield curve is used to predict the direction of interest rates and the economic expansion or contraction that could result.

There are three main yield curve shapes: normal upward-sloping curve, inverted downward-sloping curve, and flat.

Yield curve rates are published on the U.S. Department of the Treasury’s website each trading day.

Key Takeaways

Yield curves plot the interest rates of bonds of equal credit and different maturities.
The three types of yield curves include normal, inverted, and flat.
Normal curves point to economic expansion while downward-sloping curves point to economic recession.
Yield curve rates are published on the U.S. Department of the Treasury’s website each trading day.

Using a Yield Curve

A yield curve is a benchmark for other debt in the market, such as mortgage rates and bank lending rates. Over time, the yield curve can predict changes in economic output and growth.

The most frequently reported yield curve compares the three-month, two-year, five-year, 10-year, and 30-year U.S. Treasury debt. Yield curve rates are available at the Treasury's interest rate websites by 6:00 p.m. ET each trading day.

A visual representation of the curve is easy to build using an Excel spreadsheet.

Some investors use the yield curve to make investment decisions based on the likely direction of bond rates.

Types of Yield Curves

Normal Yield Curve

A normal yield curve shows low yields for shorter-maturity bonds increasing for bonds with a longer maturity. The curve slopes upwards. This curve indicates that yields on longer-term bonds continue to rise, responding to periods of economic expansion.

Sample yields on the curve may include a two-year bond that offers a yield of 1%, a five-year bond that offers a yield of 1.8%, a 10-year bond that offers a yield of 2.5%, a 15-year bond offers a yield of 3.0% and a 20-year bond that offers a yield of 3.5%.

Some bond investors will use a roll-down return strategy and sell a bond as it moves toward its maturity date. Also known as riding the curve, the strategy works in a stable rate environment as the bond's yield falls and the price rises. Investors hope to capture profit from the rise in bond prices.

A normal yield curve implies stable economic conditions and a normal economic cycle. A steep yield curve implies strong economic growth, with conditions often accompanied by higher inflation and higher interest rates.

Inverted Yield Curve

An inverted yield curve slopes downward, with short-term interest rates exceeding long-term rates.

This type of yield curve corresponds to a period of economic recession when investors expect yields on longer-maturity bonds to trend lower in the future.

In an economic downturn, investors seeking safe investments tend to choose longer-dated bonds over short-dated bonds, bidding up the price of longer bonds and driving down their yield.

An inverted yield curve is rare but suggests a severe economic slowdown. Historically an inverted yield curve has been a warning of recession.

Flat Yield Curve

A flat yield curve shows similar yields across all maturities, implying an uncertain economic situation. A few intermediate maturities may have slightly higher yields, which causes a slight hump to appear along the flat curve. These humps are usually for mid-term maturities of six months to two years.

The curve shows little difference in yield to maturity among shorter and longer-term bonds. A two-year bond may offer a yield of 6%, a five-year bond of 6.1%, a 10-year bond of 6%, and a 20-year bond of 6.05%.

In times of high uncertainty, investors demand similar yields across all maturities.

What Is a U.S. Treasury Yield Curve?

The U.S. Treasury yield curve is a line chart that allows for the comparison of the yields of short-term Treasury bills and the yields of long-term Treasury notes and bonds. The chart shows the relationship between the interest rates and the maturities of U.S. Treasury fixed-income securities.

The Treasury yield curve is also called the term structure of interest rates.

What Is Yield Curve Risk?

Yield curve risk refers to the adverse effect of a shift in interest rates on the returns from fixed-income instruments such as bonds.

Yield curve risk stems from the fact that bond prices and interest rates have an inverse relationship to one another. The prices of bonds in the secondary market decrease when market interest rates increase and vice versa.

How Can Investors Use the Yield Curve?

Investors can use the yield curve to make predictions about the economy that affect their investment decisions.

If the bond yield curve indicates an economic slowdown, an investor might move their money into defensive assets that traditionally do well during a recession. If the yield curve becomes steep, suggesting future inflation, an investor might avoid long-term bonds with a yield that will erode against increased prices.

The Bottom Line

There are three main yield curve shapes: normal upward-sloping curve, inverted downward-sloping curve, and flat. The slope of the yield curve predicts interest rate changes and economic activity.

Investors can use the yield curve to make investment decisions that factor in the likely direction of the economy in the near future.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

Federal Reserve Bank of Chicago. "Chicago Fed Letter, No. 404, 2018: Why Does the Yield-Curve Slope Predict Recessions?"
U.S. Department of the Treasury. "Daily Treasury Par Yield Curve Rates."
U.S. Department of the Treasury. "Resource Center, Treasury Yield Curve Methodology."

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