Yield Curve
In short
Chart of Treasury yields across maturities — shape predicts economic cycles
Normally, long-term bonds yield more than short-term ones (upward sloping). When short-term yields exceed long-term (inverted curve), it's historically predicted every US recession in the past 50 years. Investors call this the most reliable recession indicator.
The yield curve plots interest rates across Treasury maturities. The 2-year/10-year spread is most watched. An inverted yield curve (2Y > 10Y) means banks can't profitably lend (they borrow short, lend long), choking credit. Inversion typically leads recession by 12-18 months.
Formula
Spread = 10-Year Treasury Yield - 2-Year Treasury YieldThresholds
- < -0.5
- Deeply inverted — strong recession signal
- -0.5 to 0
- Slightly inverted — warning sign
- 0-0.5
- Flat — uncertain outlook
- 0.5-2
- Normal — healthy credit conditions
- > 2
- Steep — strong growth expected
Related concepts
- Treasury Yield — Treasury yields are the interest rates the US government pays to borrow money. They're the foundation of all financial pricing. When 10-year yields rise, it hurts stocks (especially growth stocks) because bonds become a more attractive alternative.
- Fed Funds Rate — The Fed funds rate is the interest rate banks charge each other overnight. When the Fed raises it, borrowing becomes more expensive everywhere — mortgages, car loans, business loans. Higher rates usually hurt stocks, especially growth stocks.
- Credit Spread — Credit spreads measure how much extra yield investors demand to hold corporate bonds instead of safe government bonds. Widening spreads mean investors are worried about defaults — a warning sign for stocks too.
- Recession Probability — Economists combine yield curve data, unemployment trends, and other indicators to estimate the probability of recession. Above 30% is a warning; above 50% suggests recession is more likely than not.