Plotting yields against maturity
Different-maturity bonds have different yields. Plot yield (y-axis) against maturity (x-axis) for, say, US Treasuries — you get the yield curve. It's the most-watched chart in fixed income, often a single image summarizing what bond markets think about the future.
Three classic shapes:
- Normal (upward-sloping): longer maturities have higher yields. The most common shape in most periods. Reflects "lenders want compensation for tying money up longer."
- Flat: short and long yields about the same. Often signals uncertainty or transition between regimes.
- Inverted (downward-sloping): short yields exceed long yields. Less common, historically associated with upcoming recessions in the US.
Why the curve usually slopes up
Two main forces:
Term premium. Lenders extending money for 30 years bear more uncertainty than lenders making 1-year loans (inflation can change, defaults can happen, etc.). They demand extra compensation — the term premium — for that uncertainty.
Expected future short rates. The 10-year yield is approximately the average of expected 1-year yields over the next 10 years. If markets expect the central bank to keep rates steady or rising, the 10-year sits above the current 1-year.
Combine the two and you get the upward slope as the typical shape.
Why inversions matter — the recession indicator
When short yields exceed long yields (typical comparison: 2-year vs. 10-year), markets are saying: "we expect short rates to fall in the future." That usually means markets expect the central bank to cut rates, which they do during recessions. So inversions historically precede US recessions, often by 6-18 months.
The track record is strong but not perfect. Every US recession since the late 1960s has been preceded by 2-10 inversion. Not every inversion has led to a recession (a couple of false signals). It's a useful warning, not a guarantee.
The 2022-2023 inversion preceded the slowdown that the Fed maneuvered through cycle without a deep US recession (so far). Whether that breaks the pattern depends on how things unfold from 2025 onward.
Reading the curve, not just the level
Beyond shape, the spread between specific points is informative:
- 2y-10y spread: the most-cited recession indicator
- 3m-10y spread: some prefer this (uses Fed-controlled short rate)
- 10y-30y spread: reflects very-long-term inflation expectations
The shape tells stories about market expectations across the time horizon. A steep curve = "growth ahead, central bank patient." A flat curve = "uncertainty about future." Inverted = "recession likely."
The takeaway
Yield curve = yield plotted against maturity. Normal shape upward-sloping (term premium + expected future rates). Inversion (short above long) is historically a US recession leading indicator. Specific spreads (2y-10y, 3m-10y) tell richer stories. Reading the curve is a free macro signal anyone can pull up daily.