Yield curve
Family IX · Macro
Not to be confused with bond yield.
Yield curve is a graphical representation of the relationship between the yield on debt securities and their time to maturity. It is constructed from bonds of the same credit quality, typically sovereign issues, so that differences in yield reflect only differences in maturity. The shape of the curve is a widely watched indicator of market expectations for interest rates, inflation and economic growth.
Construction and shapes
A yield curve is built by plotting the yields of a set of bonds against their remaining maturities. The most common version uses government bonds, such as US Treasuries or UK gilts, because they share the same issuer and therefore similar credit risk. The curve can take several shapes:
- Normal (upward sloping): longer maturities offer higher yields, reflecting the greater uncertainty and typically higher inflation expectations over time.
- Inverted (downward sloping): shorter maturities offer higher yields than longer ones, often seen as a signal of expected economic slowdown or rate cuts.
- Flat: yields are similar across maturities, indicating uncertainty about future rate direction.
- Humped: yields rise to a peak at intermediate maturities and then fall.
The curve is not directly observable; it is estimated from the prices of coupon-bearing bonds, which may require bootstrapping or fitting methods to derive zero-coupon yields.
Worked example
Consider four hypothetical government bonds, all with the same credit quality, each priced to yield as follows:
Plotting these points produces an upward-sloping yield curve. The spread between the 10-year and 1-year yields is 0.75 percentage points (75 basis points), a common measure of the curve's steepness.
Interpretation and uses
The yield curve is used to infer market expectations for future short-term interest rates, inflation and economic activity. An inverted curve, where short-term yields exceed long-term yields, has historically preceded recessions in several economies, though the timing and reliability vary by country and period. Central banks and analysts monitor the curve to gauge the stance of monetary policy and the transmission of rate changes. The curve also serves as a benchmark for pricing other debt, such as corporate bonds, which are typically quoted at a spread over the corresponding government yield.
Often confused with
- bond yield
- A bond yield is the return an investor receives from holding a particular bond, expressed as a percentage of its price, whereas a yield curve plots yields across many bonds of different maturities. The visible sign is that a bond yield is a single number for one security, while a yield curve is a line or set of points across maturities.