5 Things You Should Know About the Treasury Yield Curve

You may have heard about an inverted Treasury yield curve being a recession predictor.

Treasury yields go up and down based on how many investors are purchasing Treasury notes and bonds. 

And the shape of the yield curve provides clues on how those investors are feeling about the future. 

Here are 5 things you need to know about the yield curve… starting with what a Treasury yield even is.

What Is a Treasury Yield?

When investors buy a Treasury bond or note they are essentially giving the government a loan with interest. 

Treasury notes range in length from one month up to 10-years while Treasury bonds are either 20 or 30 years.

That length is how long the government has to pay back the loan to the investor.

And each of those securities has a different yield, which is basically an interest rate.

When the government pays the investor back at the maturity date, that payment will include the original investment plus interest earned.

How Do Treasury Yields Change?

Each Treasury security has a baseline yield determined by the Treasury Department. 

But those yields fluctuate above and below that baseline based on supply and demand. 

When an influx of investors buys one type of security, the yield goes down and it can be purchased at a discount. 

And when there is lower demand, the yield goes up and can be purchased at a premium.

What Is The Treasury Yield Curve?

The Treasury yield curve is a line graph that shows the difference in Treasury yields over time. 

A normal yield curve looks like this:

As you can see, the yield on the 1-month Treasury note is the lowest with the yield on the 30-year Treasury bond being the highest. 

In normal economic times, this is how the curve should look. 

This type of curve implies investors are feeling good about the long-term future of the economy and are willing to loan their money to the government for longer. 

What Is An Inverted Yield Curve?

An inverted yield curve is when short-term Treasury securities have a higher yield than long-term securities. 

A simple inverted yield curve looks like this:

But most analysts will refer to a “spread” when talking about an inverted yield curve. 

The spread is the difference between one short-term yield and one long-term yield. 

The most closely tracked spread is between the 2-year Treasury yield and the 10-year Treasury yield.

When the yield on the 2-year note is higher than the 10-year note, the difference between them is negative. 

And that looks like this:

Credit: Federal Reserve Bank of St. Louis

Charts like this track the 10-year yield minus the 2-year yield. 

When the 2-year yield is higher, you get a negative number. 

What Does the Yield Curve Signal About the Economy?

Treasury yield curves are used by analysts to predict the future of the economy. 

When the yield curve is normal, it signals strength in the short term. 

Investors are willing to purchase shorter securities because they do not see an impending economic downturn.

But an inverted yield curve is considered a recession warning sign. 

The curve inverts as investors flee short-term securities because they’re worried about the state of the economy in the near future. 

Analysts view an inversion between the 2-year and 10-year Treasury yield as a signal that a recession is coming in the next year or two. 

And it’s a pretty reliable indicator.

That spread has inverted before every single recession since 1955. 

The market is now eyeing the Treasury market for warning signs as the Fed works to tackle inflation in the U.S. economy.