By the FinLingo Team | Capital markets practitioner, front office experience at a major European investment bank. FinLingo covers 342 lessons from bonds to exotic derivatives. About · Last updated:
The yield curve is a graph that plots interest rates (yields) against maturities for bonds of the same credit quality. Typically, it shows government bond yields from 3 months to 30 years. The shape of the curve tells you what the market expects about future rates, growth, and risk.
A normal (upward-sloping) curve means longer maturities pay higher yields. This is the most common shape — investors demand more compensation for locking their money up longer. A flat curve means short and long rates are similar, often signalling a transition. An inverted curve means short-term rates exceed long-term rates. Inversions have preceded every US recession in the last 50 years.
As of early 2024, the US curve was inverted: the 2-year Treasury yielded 4.5% while the 10-year yielded 3.8%. This 70-basis-point inversion reflected the market's expectation that the Fed would cut rates — short rates are high now (Fed policy) but expected to be lower in the future (cuts priced in). Whether this correctly predicted a recession was, as always, uncertain in real time.
The yield curve contains implicit forward rates. If the 1-year rate is 5% and the 2-year rate is 4.5%, the market-implied 1-year forward rate starting in 1 year is approximately 4%. This is the rate you can lock in today for a loan starting next year. Forward rates are extracted by bootstrapping the yield curve — a fundamental skill in fixed income.
Every fixed-income instrument is priced off the yield curve. Bond prices, swap rates, mortgage rates, and corporate borrowing costs all derive from it. Central banks target the short end. Market expectations drive the long end. The curve is the most important single chart in all of finance.
An inverted yield curve means short-term interest rates are higher than long-term rates. This typically signals that the market expects rate cuts in the future, often because a recession is anticipated. Every US recession since the 1970s was preceded by a yield curve inversion, though not every inversion leads to a recession.
The x-axis shows maturity (3 months to 30 years), and the y-axis shows the yield for each maturity. An upward slope means investors demand higher yields for longer maturities (normal). A downward slope (inversion) means short-term rates exceed long-term rates. The steepness of the curve indicates how much additional yield investors require for extending maturity.
Forward rates are future interest rates implied by the current yield curve. If the 1-year rate is 5% and the 2-year rate is 4.5%, the implied 1-year rate starting in 1 year is approximately 4%. Forward rates are not predictions, they are no-arbitrage rates that can be locked in today through the forward market.
FinLingo covers yield curves and forward rates in Level 1 — 5 units on interest rate fundamentals. Completely free.
Start Free