Bond Yield Curve
The yield curve is a graphical depiction of the different interest rates paid by bonds with the same level of risk but yields to maturity (interest rates).
Typically, when people talk about a yield curve, they are referring to the difference in interest rates paid between three months to thirty years.
The graph shows the investor their possible earnings based on the money they lend for a given period.
The y-axis of the graph represents the interest rate, and the x-axis shows the time to maturity.
What Is the Yield Curve?
There are three key types of yield curve shapes:
Normal: A Normal (upward sloping) yield curve means that investors expect short term interest rates to rise.
This means that bonds with a longer maturity have higher yields compared to short-term bonds due to risks associated with time.
This shape is also the most intuitive since you would expect more money over time.
For example: 3-year notes pay 0.2%, while 5-year notes pay 0.5%, and 30-year notes pay 3%
Inverted: A yield curve that slopes downward is called an inverted yield curve, and signifies that shorter-term yields are worth more than the longer-term.
This is usually a signal or recession of falling interest rates.
When the yield curve takes on an inverted shape, it is perceived as indicative of an economic downturn.
Flat: In a flat yield curve, the short and long-term yields are relatively similar.
A flat yield curve usually occurs when there is a change between a normal yield curve and an inverted yield curve, or vice versa.
The greater the slope of the curve means the greater expectation of interest rate change.
However, the yield curve is only an expectation and may or may not occur.
The Yield curve can also indicate where the economy and inflation rates might be moving.