Explainer-What is the Treasury yield curve and what is it telling us?

Reuters

Published Jun 23, 2021 01:45PM ET

By Karen Pierog

(Reuters) - A hawkish shift from the U.S. Federal Reserve last week has focused attention on the shape of the yield curve. Here’s a short primer explaining what the yield curve is and how its shape may reflect expectations of the economy’s trajectory.

WHAT IS THE U.S. TREASURY YIELD CURVE?

It is a plot of the yields on all Treasury securities ranging from one-month bills to 30-year bonds.

Normally, it has an arcing, upward slope because investors expect more compensation for taking on the added risk of owning government debt as maturities grow longer. That means a 30-year bond would yield much more than a one-month bill or five-year note. Bond yields move inversely to prices.

WHAT IS A STEEP OR FLAT YIELD CURVE?

If the gap between yields on shorter-maturity and longer-term debt, as measured in basis points, widens substantially, the yield curve is called steep. That could signal expectations of higher economic growth and inflation.

A contracting gap indicates the curve is flattening with smaller yield differentials between short- and long-term debt. This is a possible indicator of factors like economic uncertainty, easing inflation concerns, and anticipation of tighter monetary policy.

WHAT HAPPENED TO THE YIELD CURVE AFTER LAST WEEK'S FEDERAL RESERVE MEETING?

A majority of Fed policymakers shifted their projections for the first interest rate hike into 2023 amid signs of accelerating inflation, surprising markets and sparking a sharp rise in yields on two- and five-year notes, which are the most sensitive to interest rate changes.

Long-term yields subsequently fell, flattening the yield curve between five-year notes and 30-year bonds, with the gap shrinking to its narrowest since August 2020 on Monday.