Quick Answer
A yield curve plots interest rates across maturities. A positive (normal) curve slopes up, with long-term rates higher than short-term, signaling expansion. An inverted (negative) curve slopes down, with short-term rates higher than long-term, often warning of recession. A flat curve sits level, signaling transition.
Start here because the yield curve is the picture of where rates stand across maturities, and its shape is the tested part. Three shapes, three slopes, three signals: hold all three side by side the whole section.
What a Yield Curve Is
A yield curve is a single line that shows how interest rates change as you move from short maturities to long ones.
- Yield curve: a plot of the yields (interest rates) on bonds of the same credit quality across different maturities, from short-term to long-term. For interest-rate futures, the relevant curve is the U.S. Treasury curve (Treasury bills, notes, and bonds).
- Its slope is the whole story: the slope describes how short-term rates compare to long-term rates. That comparison is what defines the three shapes, and each shape carries an economic signal.
Positive (Normal) Yield Curve
The positive curve is the everyday shape, and it slopes upward because lenders want more yield to tie up money for longer.
- Positive (normal) yield curve: slopes upward. Long-term rates are HIGHER than short-term rates.
- Why it is the usual shape: lenders demand extra yield to commit money over a longer horizon (more time means more risk), so longer maturities normally pay more.
- What it signals: economic expansion and normal, stable conditions.
Inverted (Negative) Yield Curve
The inverted curve is the reverse of normal, and it is the shape the exam tries hardest to flip on you.
- Inverted (negative) yield curve: slopes downward. Short-term rates are HIGHER than long-term rates. This is the reverse of the normal curve.
- What it signals: it often precedes or signals a recession. It has been a reliable warning because investors expect long-term rates to fall, so they accept lower yields to lock in longer maturities now.
Exam Tip: Gotchas
- Do not flip the inverted curve. On an inverted (negative) curve, short-term rates are HIGHER than long-term rates, and it slopes down. On a normal (positive) curve, long-term rates are higher, and it slopes up. The classic trap says the inverted curve has long-term rates on top: it does not.
- Match the shape to the signal. Normal means expansion, inverted means recession warning, and flat means transition. If a question gives you a shape and asks what it signals (or the reverse), these three pairings are the answer.
Flat Yield Curve
The flat curve is the in-between shape, where the short end and the long end have drifted close together.
- Flat yield curve: shows similar rates across all maturities. Short-term and long-term rates are roughly equal, so the line sits nearly level.
- What it signals: uncertainty, usually a transition as the curve shifts between normal and inverted (or back).
Here are the three shapes side by side, the way the exam contrasts them.
| Shape | Slope | Short-term vs. long-term rates | Typical signal |
|---|---|---|---|
| Positive (normal) | Upward | Long-term higher than short-term | Economic expansion / normal conditions |
| Inverted (negative) | Downward | Short-term higher than long-term | Often precedes/signals a recession |
| Flat | Roughly level | Short-term and long-term about equal | Uncertainty / transition between the other two |
Think of it this way: picture the curve as a hill drawn from short maturities on the left to long ones on the right. A normal curve walks uphill (pay more to lend longer). An inverted curve walks downhill (short rates start high and long rates sit lower), and that downhill slope is the market bracing for a slowdown. A flat curve is level ground, the market unsure which way the next move goes.
Rates and Interest-Rate Futures Prices Move Opposite
This is the payoff of the whole unit: once you can read where rates are going, you know where interest-rate futures prices are going, because they move the other way.
- The inverse relationship: interest-rate futures prices move opposite to interest rates. When rates rise, Treasury note and bond futures prices fall; when rates fall, those futures prices rise.
- Why it works: the contract sits on top of bonds, and bond prices move inversely to yields. If prevailing rates climb, an existing bond's fixed coupon is worth less, so its price drops, and the futures price drops with it.
- The exam read, as cause and effect:
- Expecting rates to rise → interest-rate futures prices fall → bearish → a trader would go short.
- Expecting rates to fall → interest-rate futures prices rise → bullish → a trader would go long.
Exam Tip: Gotchas
- The rate/price relationship is inverse, and it is the single most flippable fact in this unit. Rates UP means interest-rate futures prices DOWN; rates DOWN means prices UP. If a question says rates are expected to climb and asks about Treasury-futures prices, the answer is that prices fall.
- Rising rates is bearish, not bullish, for interest-rate futures. It feels backward because higher rates sound like "more," but for these futures higher rates mean lower prices. Expecting rates to rise, a trader goes short; expecting rates to fall, a trader goes long.
Memory Aid: Rates and interest-rate futures prices ride a seesaw: push one end up and the other drops. Rates up, prices down; rates down, prices up. They never point the same way.