Treasury Yield Curve

Beware of the flattening yield curve

Financial advisor discussing Treasury yield curve with her client

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The U.S. Treasury yield curve compares the yields of short-term Treasury bills with long-term Treasury notes and bonds. The U.S. Treasury Department issues Treasury bills for terms of less than a year. It issues notes for terms of two, three, five, and 10 years. It issues bonds in terms of 20 and 30 years. All Treasury securities are often called notes or Treasurys for short.

Understanding Yields

The Treasury Department sets a fixed face value and interest rate for Treasurys. It then sells them at an auction. High demand drives the price above the face value. That decreases the yield because the government will pay back only the face value plus the stated interest rate.

Low demand drives the price below the face value. That increases the yield because the buyer paid less for the bond but receives the same interest rate. Yields always move in the opposite direction of Treasury bond prices. Treasury yields continuously change because they are resold daily on the open market.

Treasury bills, which are of short duration, don't usually pay as high a yield as medium-term notes and long-term bonds. Investors don't expect a high return rate for keeping their money tied up for a short period. But they do expect a higher return for keeping their money out of circulation for decades.

It's hard to imagine that someone would buy a 30-year Treasury bond and just let it sit, knowing the return on their investment was only a few percentage points. But some investors are so concerned about losses that they are willing to forgo a higher return on their investment in the stock market or real estate. They know the federal government won't default on the loan.

In a world of uncertainty, many investors are willing to sacrifice a higher return for that guarantee. That's important, even though investors don't buy Treasurys and hold them. They resell them on the secondary market. That's where holders of Treasurys sell them to institutional investors such as pension funds, insurance companies, and retirement mutual funds.

Three Types of Yield Curves

The three types of yield curves can tell you how investors feel about the economy. For that reason, they are a useful indicator of economic growth.

normal yield curve is when investors are confident. They shy away from long-term notes, causing those yields to rise steeply. They expect the economy will grow quickly. Mortgage interest rates and other loans follow the yield curve. When there's a normal yield curve, a 30-year fixed mortgage will require you to pay much higher interest rates than a 15-year mortgage. If you can swing the payments, you'd be better off trying to qualify for the 15-year mortgage.

flat yield curve is when the yields are low across the board. It shows that investors expect slow growth. It could mean that economic indicators send mixed messages, and some investors expect growth while others aren't as sure. When the yield curve is flat, you aren't going to save as much with a 15-year mortgage. You might as well take the 30-year loan and invest the savings for your retirement. Better yet, apply the savings against the principal and look toward the day you can own your home free and clear.

A flat yield curve means that banks probably aren't lending as much as they should because they don't receive a lot more return for the risks of lending out money for five, 10, or 15 years. As a result, they only lend to low-risk customers. They are more likely to save their excess funds in low-risk money market instruments and Treasury notes.

An inverted yield curve forecasts a recession. It's when the yields on bonds with a shorter duration are higher than the bond yields that have a longer duration. Investors have little confidence in the near-term economy. They demand more yield for a short-term investment than for a long-term one. They would prefer to buy long-term bonds and tie up their money for years, even though they receive lower yields. The yield curve inverted before both the 2001 and 2008 recessions.  


There are some excellent recent examples of the conditions that create a flat yield curve. The details of the following examples are summarized in the table below.

On January 31, 2011, the yield curve reached a post-recession peak. The two-year note yield was 0.58. That's 2.84 basis points lower than the 10-year note yield of 3.42. That difference is called the Treasury yield spread. The most commonly quoted spread is between the two-year note and the 10-year note. That spread revealed an upward-sloping yield curve.

The yield curve has flattened since then. In 2012, the economy was growing at a healthy rate of 2%, but the eurozone debt crisis created a lot of uncertainty. When the monthly jobs report came in lower than expected, panicked investors sold stocks and bought Treasurys. On June 1, 2012, the 10-year Treasury note hit a 200-year low in intraday trading. The yield on the two-year note was 0.25, while the yield on the 10-year was 1.47. Investors had become less optimistic about long-term growth. They didn't require as much of a yield to tie up their money for longer. The spread fell to 1.22.

On July 1, 2016, the 10-year Treasury yield hit a new record low of 1.385 during intraday trading as investors worried about Brexit, Great Britain's vote to leave the European Union. By then, the yield curve had become even flatter. The spread was just 0.87. Investors were not confident about future growth. It's also because the Fed raised the fed funds rate in December 2015. That forced the yield higher on short-term Treasury bills.

Since then, the yield curve has continued to flatten. Even though the 10-year Treasury yield has risen above 3%, the short-term yields have risen faster. As a result, the spread between the 10-year and five-year notes has shrunk.

On December 3, 2018, the yield curve inverted.  The yield on the short-term three-year note was higher than the yield on the long-term five-year note. It's an unusual situation when investors demand more yield for the short-term bills than they do for the longer-term notes and bonds. They do this if they expect the economy to do worse in three years than in five years. 

On August 12, 2019, the 10-year yield hit a three-year low of 1.65%. That was below the 1-year note yield of 1.75%. On August 14, the 10-year yield briefly fell below that of the 2-year note. Also, the yield on the 30-year bond briefly fell below 2% for the first time. Although the dollar was strengthening, it was due to a flight to safety as investors rushed to Treasurys.

Significant Events in the Yield Curve

The following table shows the yield at close for the presented dates:

Treasury Security 1/31/11 6/1/12 7/1/16 4/24/18 11/8/18 12/3/18 3/22/19 8/12/19
1-month bill 0.15 0.03 0.24 1.70 2.21 2.30 2.49 2.09
3-month bill 0.15 0.07 0.28 1.87 2.35 2.38 2.46 (Inversion) 2.00 (Inversion)
6-month bill 0.17 0.12 0.37 2.05 2.51 2.56 2.48 1.94 (Inversion)
1-year note 0.26 0.17 0.45 2.25 2.74 2.72 2.45 (Inversion) 1.75 (Inversion)
2-year note 0.58 0.25 0.59 2.48 2.98 2.83 2.31 (Inversion) 1.58 (Inversion)
3-year note 0.98 0.34 0.71 2.63 3.05 2.84 2.24 (Inversion) 1.51 (Inversion)
5-year note 1.95 0.62 1.00 2.83 3.09 2.83 (Inversion) 2.24 (Inversion) 1.49 (Inversion)
7-year note 2.71 0.93 1.27 2.95 3.17 2.90 2.35 1.56
10-year note 3.42 1.47 (200-year intra-day low) 1.46 (New intra-day low: 1.385) 3.00 (1st time since 2014) 3.24 (7 year high) 2.98 2.44 (Inversion) 1.65 (3-yr. low)
20-year note 4.33 2.13 1.81 3.08 3.36 3.15 2.69 1.92
30-year bond 4.58 2.53 2.24 3.18 3.43 3.27 2.88 2.14
2- to 10-yr. spread 2.84 1.22 0.87 0.52 0.26 0.15 0.57 0.07