Yield curves are used to plot the interest rates of different bonds at a particular point in time. In order for bonds to be compared using a yield curve, the must have equal credit quality (or bond ratings), but different maturity dates. The X-axis corresponds to the maturity dates, while the Y-axis corresponds to the yield values. One of the most common and useful yield curves is used to describe the US Treasury debt at three-month, two-year, five-year and 30-year increments. This curve acts as a benchmark for mortgage rates and bank lending rates, and can also be studied to predict upcoming changes in economic output and growth.
An example of a normal yield curve. Image Credit: Pcb21 (CC by 3.0)
Yield curves come in three main shapes, each of which indicate a different outlook for the economy. A normal yield curve slopes upward, meaning that long-term bonds have a higher yield than short-term bonds. This pattern occurs during periods of expected economic growth. A flat yield curve, in which all bonds have a similar yield despite maturity dates, can be a sign of economic transition. Finally, an inverted yield curve, the rarest type, occurs when short-term bonds have a higher yield than long-term bonds, indicating a recession.
An example of an inverted yield curve. Image Credit: Pcb21 (CC by 3.0)
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