The Shape of the U.S. Treasury Yield Curve

April Investor TrustINdiana

What the Shape of the U.S. Treasury Yield Curve Suggests About Economic Expectations

The yield curve for U.S. Treasuries (yield curve) refers to the relationship between the yield on short-term U.S. Treasury bills and progressively longer-term Treasury notes and bonds. In general, Treasury bills are issued with terms to maturity of one year or less. By contrast, Treasury notes and bonds are issued with longer terms to maturity of between 2- and 10-years and 10- and 30-years, respectively. The shape of the yield curve refers to the relative difference, or “spread,” between longer-term and shorter-term yields. While the shape of the yield curve is constantly evolving in response to a myriad of factors, there are three commonly referenced yield curve formations: normal, flat, and inverted.

 

The Normal Yield Curve

 A normal yield curve is characterized by lower yields for shorter-term maturities and progressively higher yields for longer-term maturities. A normal yield curve is the most common and generally reflects a stable and expanding economy. The relative steepness of a normal yield curve can provide clues about the current and expected pace of economic activity. For example, a comparatively steeper normal yield curve can reflect accelerating rates of economic growth while a less steep normal yield curve can reflect a slowing pace of economic expansion.

 


The Flat Yield Curve

As implied by its name, a flat yield curve is characterized by similar yields across both short-term and long-term maturities. In general, a flat yield curve often reflects uncertain or deteriorating economic conditions. Against a backdrop of economic uncertainty, there is little differentiation between short-term and long-term yields, as they converge towards a common level. In a deteriorating economic environment, a flat yield curve may reflect concerns of further economic weakness.

 


The Inverted Yield Curve

An inverted yield curve results when short-term yields are higher than longer-term yields. Inverted yield curves are rare and generally reflect periods of significant economic slowdown and often recession. Under such circumstance, investors may accept lower long-term yields because they believe economic conditions may deteriorate further and that short-term yields may be lowered to stimulate economic activity. Inverted yield curves have historically exhibited a strong correlation with economic recession.

 

The persistent flattening trend of the current U.S. Treasury yield curve has been the subject of much discussion amongst economists and market participants. Recently the spread between 2- and 10-year Treasury yields has fallen to its lowest level in over a decade.


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