A three-month Treasury yields 5.2%. A ten-year Treasury yields 4.0%. These are hypothetical annual quotes from the same day. Why would lending to the same government for much longer pay less?
You might expect an extra reward for waiting. But the short loan creates another decision when it ends: what rate can you earn when you lend the money again? The next three months might pay less. A long yield reflects expectations about those future rates as well as the risk of holding the bond.
One date, several maturities
The Treasury yield curve compares yields on similar US government debt with different maturities on one date. Yield is the annual rate of return implied by a bond's price; maturity is the time until repayment.
The horizontal axis measures loan length. The ten-year point is the yield available for ten-year debt on the date of the snapshot. Moving right means lending for longer, not traveling into the future.
Like other interest-rate quotes, these yields use an annual scale. The 5.2% quote does not mean you earn 5.2% in three months.
- Normal yield curve: yields rise as maturities lengthen.
- Flat yield curve: short and long yields sit near the same level.
- Inverted yield curve: longer maturities offer lower yields than shorter ones.
“Normal” simply names the conventional upward shape. All three lines here reach 4.0% at ten years. The same long yield can sit on very different curves.
Read the spread's sign
A term spread measures the gap between two yields. Subtract the shorter-maturity yield from the longer-maturity yield.
Add a two-year yield of 4.6% to our opening quotes. Ten-year minus two-year gives 4.0% − 4.6% = −0.6 percentage points, or −60 basis points (bp). This is the 2s10s spread.
Ten-year minus three-month gives 4.0% − 5.2% = −1.2 percentage points, or −120 bp. This is the 3m10y spread. Both names put the shorter maturity first; the subtraction starts with the longer one.
| Spread | Long yield | Short yield | Difference |
|---|---|---|---|
| 2s10s | 4.0% | 4.6% | −60 bp |
| 3m10y | 4.0% | 5.2% | −120 bp |
The minus sign tells you the longer loan offers less yield. Both pairs are inverted on our example day. A real curve can slope up in one stretch and down in another, so different pairs can tell different stories.
“The curve inverted” is an incomplete headline. Which pair, and for how long? Different parts can invert on different dates, and a one-day dip can disappear in a monthly average.
Why lending longer can pay less
Long yields reflect two ingredients: the short rates investors expect over the bond's life and the term premium, compensation for holding longer-term interest-rate risk.
When investors expect the Fed to cut rates as the economy weakens, long yields can fall below high short yields. The market can price in a slowdown before it appears in economic data.
The Fed can also cut as inflation cools while the economy keeps growing. Rate cuts are not reserved for recessions.
The term premium changes too. It can even be negative, putting the long yield below the average short rate investors expect over the bond's life.
Strong demand for long bonds can raise their prices and lower their yields. Central-bank bond purchases can add to that demand and put downward pressure on the premium.
The term spread compares two quoted yields. The term premium depends on expectations about future rates, so it has to be estimated. You cannot read it straight off the curve.
Knowing that the premium is low does not tell you the recession warning is a false alarm.
A warning with an uncertain clock
A March 2018 San Francisco Fed study examined ten-year minus one-year Treasury yields from January 1955 through February 2018. That is a third maturity pair, separate from 2s10s and 3m10y.
Using a two-year window after an inversion, the study found:
- All nine US recessions in the sample had prior inversions.
- One inversion, in the mid-1960s, was a false alarm: no recession followed within two years.
- In the recession cases, the wait from inversion to onset ranged from 6 to 24 months.
That record ends in February 2018. Six months to two years is a wide window for timing a stock trade, and the observed range is no deadline for the next downturn. Nor does an inversion preceding a recession prove that investors foresaw its cause.
The New York Fed's 2006 model uses the monthly average ten-year minus three-month spread to estimate the probability of the US being in a recession twelve months later. It estimates risk for a future month; it does not set a recession start date or predict stock returns.
In our example, −120 bp tells you the ten-year/three-month pair is inverted on that day. The jobs report and output data help show whether economic weakness is already spreading. Recession dating brings that broader evidence together after the fact.
For the core reading routine, bring this risk signal to the economic calendar. To follow the Fed's influence on long yields first, the optional QE and QT lesson traces its bond purchases and the shrinking of its holdings.
In short
- The yield curve compares maturities on one date, not rates on future dates.
- A term spread is the longer yield minus the shorter yield; a negative result means that pair is inverted.
- An inversion headline needs a maturity pair and a period: one day and a monthly average tell different stories.
- The curve reflects both expected future short rates and the term premium.
- An inversion can warn about recession risk without giving you a reliable trading date.