What Exactly is the Yield Curve (and Why It Matters to You)

You’ve likely heard of the yield curve—but what exactly is it and why should you care?  

What Is the Yield Curve?

The yield curve is a visual representation of how much it costs to borrow money for different periods of time; it shows interest rates on U.S. Treasury debt at different maturities at a given point in time, typically ranging from short term (three-month or two-year) to long-term (10-year or 30-year). The shape of the yield curve reflects investor sentiment about future economic conditions and interest rate trends.

1. Normal yield curve – Upward sloping. Longer-term bonds have higher yields than short-term bonds, indicating a healthy, growing economy because lenders expect more interest for longer maturities or repayment periods.   
2. Inverted yield curve – Downward sloping. Short-term bonds have higher yields than long-term bonds, often seen as a predictor of economic recession. 
3. Flat yield curve – Flat or humped. Short- and long-term bonds offer similar yields, suggesting economic uncertainty or a transition period.

Here’s a graph comparing the three types of yield curves:

• Blue (Normal Yield Curve): Upward sloping, indicating a healthy economy
• Red (Inverted Yield Curve): Downward sloping, often a recession signal.
• Green (Flat Yield Curve): Yields are nearly the same across maturities, indicating economic uncertainty.

Why Should You Care?

As an investor, the yield curve has real implications for your wealth strategy, from bond investments to stock market performance and even borrowing costs. 

1. Investment Portfolio Adjustments

A steepening yield curve (where long-term rates rise faster than short-term rates) often signals stronger economic growth, making equities and riskier assets more attractive. On the other hand, an inverted yield curve may prompt investors to shift towards more defensive assets like bonds or dividend-paying stocks to protect portfolios from potential downturns.

2. Interest Rates and Borrowing Costs

If you’re considering taking out a mortgage, business loan, car loan, or any other form of debt, the yield curve can offer insights into future interest rate trends. A normal curve suggests borrowing costs may rise over time, while an inverted curve may indicate that rates could decline in the future.

3. Fixed-Income Investments

A flattening or inverted yield curve can diminish the appeal of investing in long-term bonds, as they may offer little to no additional yield compared to short-term bonds, potentially leading to an unfavorable risk-reward balance. This might encourage investors to focus on shorter-duration bonds or diversify into other fixed-income securities.

4. Economic and Market Forecasting

Historically, an inverted U.S. Treasury yield curve has been a reliable predictor of a recession within 12 to 18 months. There have been 11 U.S. recessions since 1957, and all of them have been preceded by a Treasury bond yield curve inversion.ⁱ

However, as we’ve seen over the past three years, no single economic indicator, including the yield curve, is an economic crystal ball, due to the influence of other economic factors. The yield curve was inverted for a record-breaking 793 days from July 2022 to December 2024 without a recession occurring during that two-year period. In late February, the U.S. 10-year Treasury yield fell below the 3-month note, briefly forming another inverted curve. 

Washington Trust Wealth Management Can Help

Your Washington Trust Wealth Management advisors closely monitor and understand the implications and limitations of the yield curve, among other economic indicators. We work with you to proactively adjust your portfolio to capitalize on opportunities and minimize risks, giving you an edge in safeguarding and growing your wealth.