Identifying Future Economic Changes With the Yield Curve
The Treasury yield curve inverts when investors foresee weaker economic conditions ahead.
The yield curve identifies changes in the economy without the need to make additional calculations. When people refer to the yield curve, they mean the graph mapping the yields of U.S. Treasury fixed-rate bills, notes and bonds on a given day.
Bonds with different maturity dates trade at different yields due to their varying interest rates. Treasury securities with the shortest terms—four weeks to 52 weeks—are called bills. Treasury notes mature in two, three, five, seven or 10 years. Treasurys with the longest terms are called bonds and mature in either 20 or 30 years.
The longer a bond’s time to maturity, the higher its interest rate is expected to be. This acts as compensation for the period when the investor’s capital is being held as a loan to the issuer. The higher interest rate accounts for the loss of purchasing power due to the eroding effects of inflation, the chance that interest rates will rise in the future and the risk that the issuer may default. The longer an investor must wait for the bond to mature, the more potential there is for their investment to lose value by one of these scenarios.