Yield curve definition
A yield curve is a line plot on a chart that shows the interest rates or yields of bonds with equal credit quality but differing maturity dates.
Short-term bonds typically offer lower yields, and long-term bonds higher yields (due to the risks associated with time), resulting in a chart that rises from left to right when the x-axis is increasing time durations of bonds, and the y-axis is increasing interest rates. This is described as a ‘normal’ yield curve.
Yields on short-term bonds are heavily influenced by central bank interest rate expectations, while the yields on long-term bonds are influenced by interest rates, but also factors like the inflation and economic growth outlook, as well as investor risk attitude. When these factors are influenced one way or another, then the bond yield curve can shift. When long-term bond yields are rising faster than short-term, the curve steepens, and it flattens when short-term bond yields rise faster than long-term. Occasionally, the yield curve can become inverted, as short-term bonds yield more than long-term bonds. This usually happens when investors expect economic growth to slow sharply whilst inflation is low, and they therefore expect central banks to cut interest rates.
Yield curves are sometimes used to plot other types of debt, including mortgage or bank lending rates.