Shapes of the Yield Curve

A yield curve is a graph or plot of interest rates that buyers of government debt demand to lend their money over various periods of time. A yield curve shows the difference in interest rates along the vertical axis and maturities (time) along the horizontal axis. The curve which most investors refer to as “the yield curve” reflects the short (4, 8, 13, 26 and 52-week bills), intermediate (2, 3, 5, 7 and 10-year notes) and long term (20 and 30-year bonds) interest rates of US Treasuries. The yield curve is a par yield curve which means that each point on the curve gives a bond’s coupon, which is its yield, and that bond’s price, which is par. The Treasury yield curve is often considered a proxy for investor sentiment and can be used by investors to help gauge the direction of the economy. The factors that can influence changes in the yield curve differ on either end. Short-term interest rates (the short end of the curve) are typically influenced by expectations of domestic monetary policy and more specifically the stance of the Federal Reserve on the federal funds rate, which is the rate at which banks can borrow cash reserves on an overnight basis. Short-term rates will often rise when the Fed is expected to raise rates and fall when it is expected to cut rates. The long end of the yield curve is influenced more by economic growth predictions, inflation and investor sentiment. 

The shape of the Treasury yield curve refers to the relative difference or “spread” between long and short-term yields. It has long been a reliable indicator of the current and future strength of the US economy. There are three types of yield curve shapes: normal, flat and inverted. A normal curve slopes upward from left to right on the graph as maturities lengthen and yields rise. This makes sense. If you are a lender, you would expect to be rewarded for the increased risk you would assume in making a long-term loan versus a shorter one. This reward has a name – “term premium.” A flat yield curve is often called a yield curve in transition and occurs when short-term rates rise to the point in which they are close to long-term rates (or when long term rates fall more than short term rates). History suggests that while a flattening yield curve does not by itself reduce growth expectations it nonetheless often leads to an economic slowdown and lower interest rates. An inverted yield curve occurs when short-term rates have risen above the long-run natural rate of interest. An inverted or downward sloping curve suggests yields on longer-term bonds may continue to fall, corresponding to periods of significant economic slowdown or recession usually within one year of the inversion. 

So, what is the yield curve telling us now? The yield curve continues the shape shifting path it embarked on during the global pandemic. The curve was inverted from late 2022 until early 2024, the longest continuous stretch in which 10-year Treasury yields were below 3-month yields since 1962. This long period inversion was also one of the deepest (in yield spread) in over 40 years. During 2025, we saw a normalization of the curve and a disappearance of much of the curve inversion. Today, the yield curve has reasserted it typical upward slope, with the spread between 2-year and 10-year Treasuries widening to 45 basis points (bps). Many analysts expect the curve to continue steepening as the Federal Reserve continues to cut short-term interest rates with one or two cuts projected for late 2026. With this projection in mind, it is important to remember that the yield curve is influenced as much by expectations as it is by conditions. Typically, in a Fed rate cut cycle, when short-term yields fall more rapidly than long-term yields, the widening spread steepens the shape of the curve signaling anticipation of future economic expansion. In this case, the yield curve would present as a “bull steepener.”