What exactly is a Yield curve?

The yield curve reflects the term structure of interest rates. It is a graph that shows the relationship between yield (ideally of the same risk-free quality), and the term to maturity, at a given point in time.

The yield curve takes on a variety of shapes. Each shape provides important information on interest rates, economic activity and inflationary expectations. Instrumental in this interpretation is the knowledge that shorter rates, such as 90 days, reflect expectations on Monetary Policy, and longer rates, such as 10-year bonds, reflect inflationary and economic activity expectations.

NORMAL YIELD CURVE
(upward sloping / positive)

The normal yield curve is upwards sloping because long-term bonds are more risky than short-term bonds and investors expect to be compensated with higher yields. Steepness is also an important consideration. If the below curve was steeper it would likely be because investors believe the economy will grow very quickly such as at the beginning of an economic expansion following a recession.

INVERTED YIELD CURVE
(downward sloping / negative)

Short-term yields are higher than long-term yields. Inverted curves are rare and reflect an expectation that inflation will be subdued in the future and often implies an impending recession.

FLAT YIELD CURVE

Short-term and long-term yields are roughly in line with each other. This can be seen as a predictor of an economic transition.

HUMP BACKED YIELD CURVE

In reality the yield curve can take on many shapes. A hump-backed yield curve is a combination of each of the shapes above and like the flat yield curve can be interpreted as indicating a transitionary phase. The hump can be above short and long rates or can be a dip below them.

HISTORICAL YIELD CURVE

Yearly yield curves March 1987 to March 2015