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What is the yield curve?
The yield curve is a plot of US Treasury yields from short maturities (1-month) to long maturities (30-year). Its shape encodes the market's expectations for Fed policy, growth, and inflation. A normal upward-sloping curve signals expected growth; a flat curve signals slowdown; an inverted curve (long below short) has historically preceded every US recession by 6-24 months. The most-watched spread is 10Y-2Y, but 3M-10Y is the Fed's preferred recession indicator.
- Normal
- Upward slope. Growth expected.
- Flat
- Slowdown signal.
- Inverted
- Recession warning. Watch 10Y-2Y and 3M-10Y.
- Steepening from inversion
- Often coincides with the recession itself.
The four shapes
Normal (steep upward) - short rates low, long rates high. Growth and inflation expected. Bull-steepening (long up, short flat) = inflation; bear-steepening (short up faster than long) = restrictive Fed.
Flat - front and back similar. Slowdown signal. Often a transition shape.
Inverted - long below short. Markets expect rate cuts. Recession warning.
Bull-steepening from inversion - short rates falling faster than long. The Fed is cutting. Often coincides with or just before the recession.
Key spreads to watch
- 10Y-2Y - most-watched, simplest
- 3M-10Y - Fed's preferred
- 5Y-30Y - long-end shape, term premium
- 2s5s10s butterfly - curvature
Where it fails
QE/QT distorts the term premium. Inversions in distorted regimes (like 2022-2024) have weaker recession-prediction track records than historical norms.