A yield curve is a graphical representation of yields on bonds with different maturities. The most common example is the government bond yield curve, but it is very well possible to render a yield curve for other types of bonds, such as corporate bonds, high yield bonds, etc.
The government bond yield curve is often referred to as the benchmark yield curve; the left panel of the image above shows this curve for US government bonds as of November 4, 2019.
Analysis of the yield curve helps investors determine how bond markets are positioned and in what direction they are likely headed. This type of knowledge can help you to get a handle on where we are in the economic cycle, along with what the next phase will likely be.
Each day, the US Department of the Treasury (www.treasury.gov) reports the yields for various maturities of US government bonds, ranging from 1 month up to 30 years. The table below shows these yield rates for early November 2019. Please note that all these yields are annualized; for example, for a bond with a one-month maturity, you will receive 1.58%/12 = 0.13%.
While yield curves can be built using data for all these maturities, having so many shorter-term yields on the curve usually does not add much value. In general, yield curve charts will omit many of the shorter-term yields. Our Dynamic Yield Curve tool shows the rates for 3 months, 2 years, 5 years, 7 years, 10 years, 20 years, and 30 years.
The vertical axis of a yield curve chart shows the yield, while the horizontal axis shows the maturity of the bonds (often converted into months in order to get a proper scaling on the chart). The rates for each of the different maturities are plotted on the chart. The yield curve itself is the line that connects each of these yield rates on the chart.
In general, the yield curve reflects the way investors think about risk. In a normal situation, one would expect to receive a higher compensation (yield) for longer maturities. When you lend money to the government for 20 or 30 years, it makes sense to receive a higher compensation than when you lend it for only a few months or a year.
The yield curve reflects the yields for different maturities in a very intuitive way. The shape of the yield curve line, as well as changes in that shape over time, can help investors to determine the current economic environment and signal changes in the economic climate.
Essentially, there are three possible shapes that we can see in the yield curve. A Normal curve has short-term rates lower than long-term rates; an Inverted curve has short-term rates that are higher than long-term ones; and a Flat curve has short- and long-term rates that are roughly the same.
In a normal yield curve, the yield on shorter maturities is lower than on higher maturities. The yield curve line curves gradually upward, with the increase of yield decreasing towards longer-dated bonds. The thinking is that the shorter the maturity, the less risk for the investor and, therefore, a lower yield (compensation) than for longer-dated bonds.
A normal-shaped yield curve is usually seen in an economic environment that shows normal growth and limited-to-no changes in inflation or available credit.
The chart above shows the yield curve on March 12, 2010, as the economy was starting to recover from the Great Recession. The curve is fairly steep, which is common early in a recovery period. The S&P 500 chart on the right shows the stock market beginning to recover from its low point the previous year.
An inverted yield curve refers to a situation where the shorter-dated bonds offer a higher yield than the longer ones. Despite the name, an inverted yield curve does not have to be “completely” inverted. Sometimes only part(s) of the curve are inverted; this can cause humps or dents in the curve as we would expect it to be shaped.
An inverted curve is usually seen as a signal that economic growth will soon stabilize or reverse, maybe even signaling the start of a recession. This is caused by investors thinking that the period of economic growth is or will soon be over, making them more likely to accept lower rates before they fall even further. This process can cause (partial) yield curve inversions.
Inverted yield curves are relatively rare; when they do happen, they tend to draw a lot of attention.
The example above shows the inverted yield curve on August 24, 2000, in the midst of the dot-com bubble bursting. The S&P 500 chart on the right shows that the stock market began a major downturn around the time of this inversion.
When people talk about “the yield curve inversion,” they usually refer to the 10y-2y segment; the curve is considered inverted when the 10-year yield is lower than the 2-year yield. We can see that this was the case on August 24, 2000 in the yield curve chart above.
Another way of showing that relationship is by drawing a chart of the difference between these two yields ($UST10Y-$UST2Y), as shown in the chart below.
When this relationship dips below 0, the 10-2 curve is inverted. The difference chart shows us that the yield curve was inverted for most of the year 2000, corresponding with the dot-com bubble bursting.
When the yield curve is “flat,” the yields are (more or less) the same across all maturities. This means that you will receive roughly the same compensation for lending your money out for 2 years vs. 30 years. You are not compensated for the longer (and therefore, riskier) lending period.
As the economy expands and contracts and the yield curve moves from normal to inverted, the curve has to pass the flat shape in both directions. A flat curve can therefore be seen as a transition period in the economy from one phase to another.
The chart above shows a fairly flat yield curve on July 16, 2007, a precursor to the Great Recession. The S&P 500 chart on the right shows prices flattening out as the economy transitions from recovery to recession.
Changes in the shape of the curve over time are measured by the slope of the yield curve. When there is a big difference between the short and the long end of the curve, it is considered to be a steep curve. When there is very little difference between the two ends, the curve is considered to be flat.
The changing of the curve from steep to flat is often referred to as “flattening”; similarly, the changing of the curve from flat to steep is called “steepening”.
This steepening and flattening of the curve can help investors to signal changes in the economic climate.
The yield curve is said to be flattening when long yields come down while short yields go up, which decreases the difference between the two and makes the slope less steep. Flattening typically happens when the economy is in full recovery mode.
The chart below uses our Snapshot functionality to compare the yield curve on two different dates. The darker red line is the yield curve in early 2010, while the bright red line is the curve in late 2018. As you can see, the yield on longer maturities came down while the yield on shorter maturities moved higher, changing a very steep curve in 2010 to a very flat curve in 2018.
The opposite situation, when the difference between the two ends of the curves is small but starting to increase, is called the steepening of the curve. Steep curves are generally seen at the beginning of a growth or expansion period.
The chart above shows an example of a steepening curve. In May 2007, the yield curve was very flat, with all maturities above 4.65%. From that point to August 2010, yields came down across the curve, but they came down much harder on the short end. This asymmetric decline caused a steepening of the curve.
This information on the direction of rates and the change in the shape of the curve is often used to determine where we are in the economic cycle (sometimes referred to as the business cycle). The table below shows how the yield curve typically behaves during each segment of the cycle.
The chart above shows the S&P 500 Index on a monthly scale going back to the 1970s. The red and green dashed lines mark the start and end dates of expansions and contractions in the business cycle as defined by NBER (National Bureau of Economic Research). Thus, the area from a red line to a green line marks a contraction period, while the area from green to red marks an expansion period.
The 10Y-2Y spread is plotted below the chart. Orange circles show dips below the zero line, which is where the yield curve is inverted. Notice that there is a yield curve inversion preceding every period of contraction since the late 1970s. As predicted by the table above, the yield curve is typically inverted or flat at the beginning of a recession.
It is not so much that the current shape of the yield curve can help us to solve the financial puzzle, but more so that the transition and the changing of the shape of the curve over time will provide us with clues to the potential future direction of the economy.
Combining the information that you can extract from the yield curve with the known behavior of the yield curve (in relation to the various stages of the business cycle) can help to determine where we are in the cycle, which will then help you decide between a risk-on or risk-off approach to your investments.
You can get a more granular view of the yield curve by using our Dynamic Yield Curve tool, which will also give you the possibility to see the interaction between various segments.
The Dynamic Yield Curve chart above shows the yields for various US Treasury maturities ranging from 3 months all the way up to 30 years.
The ticker symbols for the various maturities are shown in the table below the chart; you can use these as inputs in SharpCharts and other tools on the site for single-security analysis purposes.
The Dynamic Yield Curve tool allows you to create snapshots to easily compare yields from two different dates, as well as animating changes in the curve over time. For more information on this tool, please see our Dynamic Yield Curve article in the Support Center.
StockCharts offers US Treasury yield data for maturities ranging from 1 month to 30 years. Click here for a complete list of available treasury yield symbols.
Since SharpCharts can use difference symbols, we can also chart a yield spread to show when the yield curve is inverted. Simply plot $UST10Y-$UST2Y on a SharpChart, as shown below. The curve is inverted when the line drops below zero, so it is helpful to add a horizontal line at 0 on the chart.
The example below shows a brief and minimal inversion of the yield curve in August 2019.