The yield curve is a line joining the yields on government bonds of different maturities, from a few months to 30 years, on a single day. Its shape is one of the most watched signals in markets because it summarises what investors expect for interest rates, and those expectations reflect what they think will happen to inflation and growth.
What sets the shape
Two things mostly decide how long-term yields compare with short-term yields.
Expected policy rates. An investor can buy a 2-year bond, or buy a 1-year bond and then reinvest in another 1-year bond next year. If both plans were expected to earn the same, the 2-year yield would be roughly the average of today's 1-year rate and the 1-year rate expected in a year.
The term premium. Lending for longer is riskier: inflation could surprise, and the bond's price swings more (see why bond prices and yields move in opposite directions). Investors usually want a little extra yield for that, which tilts the curve upwards even when no rate changes are expected.
Worked example: expected cuts flatten the curve
Suppose the 1-year yield is 4.0% and investors expect the 1-year rate a year from now to be 3.0%, because they think the central bank will cut. Ignoring the term premium, the 2-year yield that makes both plans equal is:
(1.04 × 1.03)^½ − 1 = 1.0712^½ − 1 ≈ 3.50%
The 2-year yield (3.50%) sits below the 1-year yield (4.0%). Expected rate cuts pull longer yields down relative to short ones. If the market instead expected the rate to rise to 5.0%, the 2-year yield would be about (1.04 × 1.05)^½ − 1 ≈ 4.50%, above the 1-year yield.
Normal, flat and inverted
- Normal (upward sloping): long yields above short yields. Investors expect rates to stay put or rise, and collect a term premium for lending longer.
- Flat: long and short yields about equal. Often seen when a central bank has been raising rates and markets think it is near the end.
- Inverted: short yields above long yields. Markets expect the policy rate to come down, often because they expect weaker growth or lower inflation ahead.
Measuring the slope
A whole curve is hard to track over time, so analysts follow the gap between two points:
- 10-year minus 2-year: compares the long end with the part of the curve most driven by expected policy rates over the next two years.
- 10-year minus 3-month: compares the long end with a rate that closely tracks the current policy rate. Research at the Federal Reserve Bank of New York uses this spread in its recession-probability model.
For example, if the 10-year yield is 4.20% and the 2-year yield is 4.60%, the 10-year minus 2-year spread is 4.20 − 4.60 = −0.40 percentage points: the curve is inverted by 40 basis points.
The United States and Australia dashboards chart both kinds of slope, shade the periods below zero and list each inversion that lasted ten or more observations.
Inversions and recessions
In the United States an inverted curve has come before most recessions. New York Fed research found the 10-year minus 3-month spread inverted ahead of every US recession from the late 1960s onward. In the data on the dashboard you can see it inverted in 1989 (before the 1990-91 recession), in 2000 (before 2001), in 2006-07 (before the 2008-09 recession) and in 2019 (before the short 2020 recession, which was caused by the pandemic).
Three cautions apply:
- The lag is long and varies. Recessions have started anywhere from several months to about two years after an inversion began. An inversion says little about timing.
- It is not a perfect signal. The US curve was inverted for an unusually long time from late 2022 to late 2024. According to the NBER recession dates available when this was written (October 2026), no recession has followed it so far.
- Why the curve moved matters. An inversion caused by short rates rising quickly (a central bank tightening hard) means something different from one caused by long yields falling on fears of a slowdown. Changes in the term premium, such as large central-bank bond purchases, can also flatten the curve without any change in expectations.
Steepening and flattening
Market commentary often describes how the curve changes:
- Bull steepening: short yields fall faster than long yields, typically when markets start pricing rate cuts.
- Bear steepening: long yields rise faster than short yields, often on higher inflation expectations or a rising term premium.
- Bull flattening: long yields fall faster than short yields.
- Bear flattening: short yields rise faster than long yields, common while a central bank is raising rates.
"Bull" and "bear" refer to bond prices: yields falling means prices rising.
Australia's curve
Australia's curve follows the same logic, with the RBA's cash rate anchoring the short end. Two differences matter when reading it. Australian long-term yields move closely with US Treasury yields, so the slope partly reflects global forces rather than domestic expectations alone. And over the decade of daily data available from the RBA, the Australian 10-year minus 2-year spread has inverted less often and less deeply than the US spread, so a shallow Australian inversion is a weaker signal on its own.
How to use the slope charts
- Read the slope with the policy-rate chart beside it. A curve inverting while the policy rate is rising tells a different story from one inverting while it is steady.
- Look at the 2-year yield minus the policy rate as well. It shows whether markets expect the policy rate to rise or fall over the next two years, which is a big part of what moves the slope.
- Treat the slope as market pricing, not a forecast. It shows what investors are paying for today, including a premium for risk, and it can change quickly.
This article explains how to read the yield curve. It is general information, not a recommendation to buy or sell anything.