Yield Curve

A line plotting bond yields by maturity; inversion can signal recession risk.

A yield curve is a line graph that plots the interest rates (or yields) of bonds with equal credit quality but differing maturity dates, typically ranging from a few months to 30 years. Most commonly, investors refer to the U.S. Treasury yield curve, which reflects the yields of government debt securities. The curve serves as a benchmark for other debt in the market, such as mortgages and corporate bonds, and acts as a key barometer for economic expectations. In a healthy economic environment, the yield curve slopes upward because investors demand higher yields to lock up their money for longer periods, compensating them for inflation and time-horizon risks. When short-term yields rise above long-term yields, the curve becomes "inverted." An inverted yield curve indicates that investors expect economic growth to slow and interest rates to fall in the future, and it has historically been a highly reliable leading indicator of economic recessions. Investors monitor the shape of the yield curve to adjust their asset allocation and gauge market sentiment. A steepening curve suggests expectations of strong economic growth and rising inflation, which often favors cyclical stocks. Conversely, a flattening or inverting curve suggests caution, prompting defensive positioning. A key pitfall for investors is timing; while an inverted yield curve is a reliable warning sign, the actual economic downturn or stock market peak may not occur until many months or even years after the initial inversion.

If the 2-year U.S. Treasury note is yielding 4.50% while the 10-year U.S. Treasury note is yielding 4.00%, the yield spread (10-year minus 2-year) is 4.00% - 4.50% = -0.50% (or -50 basis points). Because the short-term yield is higher than the long-term yield, this portion of the yield curve is inverted.