What Is a Yield Curve?

A yield curve is the relationship between interest rates and time, and is determined by plotting the yields of bonds with equal credit quality against their maturities.

What Does the Yield Curve Tell You?

By looking at the yield curve of bonds having equal credit quality but differing maturity dates, the slope of the curve will give you a good idea of the future interest rate changes and economic activity.

Yield curves can take the form of three shapes: normal (upward sloping curve), inverted (downward sloping curve), and flat. A normal yield curve shows yields on longer-term bonds continuing to increase, pointing to an economic expansion. An inverted yield curve shows that short-term interest rates exceed long-term interest rates, pointing to an economic recession. When the yield curve is flat, the yields are similar across all maturities, indicating an unpredictable economic situation. 

Why Is the Yield Curve Important?

It gives insight into what the totality of all investors see within the economy and can be an indicator for evolving market conditions. The yield curve essentially reflects the opinion of all market participants, so it will give you the best idea of what is really going on with the market.

Besides helping investors determine how the market is performing, the yield curve also has a huge impact on the economy’s money supply. It can influence the ability of individuals and businesses to obtain traditional bank loans. If there are concerns about future economic growth (i.e., the flatter the curve), the market is reluctant to require higher rates, which forces banks to loan money at lower rates. Consequently, due to lower interest rates, banks are less incentivized to give loans, since there are risks involved. This negatively affects the economy, as individuals and businesses won’t be able to borrow as easily.

What Is Yield Curve Inversion?

An inverted yield curve slopes downward and can predict an economic recession. It indicates that long-term debt has lower yields than short-term debt and that shorter term bonds have higher returns than longer term bonds.

 

Wealthspire Advisors is a registered investment adviser and subsidiary company of NFP Corp.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. ©2021 Wealthspire Advisors.

Read More Financial Definitions: