In the bond market, a yield curve is a graphical representation of the relationship between the yields and different maturities of debt instruments that have similar credit ratings. Thus, the Treasury yield curve is this relationship represented for a government's debt securities, also referred to as Treasuries. The yield is essentially the return or interest rate that a bond investor expects to earn if he or she was to buy and hold a particular bond until maturity. Basically, maturity is the length of time the security will be held for before the principal is repaid. Moreover, the Treasury yield curve is a snapshot of the said relationship at a specific time, and can be used to gauge and forecast economic conditions, among other conditions.
Graphically, the Treasury yield curve is plotted with the yield on the y-axis, and the maturities on the x-axis. Treasuries come in varying maturities such as three-month, one-year, five-year, and 10-year. Hypothetically speaking, on a particular day and time the said maturities have the following yields: 1%, 2%, 4%, 5%, respectively. Then on a graph, the treasury yield curve would be an upward slope, which means that investors require a higher rate of return for holding Treasuries for longer periods. The shape of the curve can take different shapes other than an upward slope; for example, when short-term Treasuries have higher yields than long-term ones then the curve would be downward sloping, and when short-term and long-term yields are kind of the same then the curve would be relatively flat.
Among its various functions, the Treasury yield curve is generally used as a benchmark in the debt market, where any debt instrument will be set at a higher rate compared to a Treasury security of the same maturity. For instance, if the 10-year Treasury security is trading at a 5% yield, then a corporate bond with the same maturity will offer a higher yield. This is mainly because Treasuries are considered to be less risky compared to most other investments, and so they offer lower returns. In other words, since Treasuries are considered less risky, then all other debt products will offer higher rates across the maturity range. Generally, this rule is applicable whether the debt is a car loan, mortgage, corporate bonds or other debt-related products.
Furthermore, investors use the Treasury yield curve as an indicator for future interest rate levels as well as to measure and compare the value and returns across the different maturities. Moreover, the Treasury yield curve may be used as an indicator to forecast future economic conditions. For example a downward sloping curve, also referred to as a negative yield curve, can predict recessions. Conversely, an upward sloping curve indicates that investors expect solid economic growth and a rising inflation. A flat yield curve, on the other hand, suggests that there may be uncertainty in the financial markets.
