Key points
The yield curve is a chart that displays the interest rates (yields) of bonds with different maturities.
There are 4 main types of yield curves: normal, inverted, flat, and steep, each signaling different economic expectations.
A gradual upward yield curve occurs when the difference (spread) between short-term and long-term bond yields increases over time.
The yield curve can affect both the cryptocurrency market and the stock market but is particularly relevant to interest-sensitive sectors such as banking, real estate, and utilities.
What is the yield curve?
The yield curve is a chart that displays the interest rates (yields) of bonds with different maturities. The yield curve can be seen as a line comparing short-term interest rates to long-term interest rates, typically for U.S. Treasury bonds.
Bond yields change with maturity because investors require different return levels depending on the bond's term, often due to expectations about inflation, credit risk, and general economic conditions.
Therefore, the shape of the yield curve tells us a lot about investors' expectations for the economy, thus providing a kind of forecast of financial conditions. The U.S. Treasury yield curve is the most famous curve and often serves as a gauge of economic health, influencing decisions across many markets.
Types of yield curves
In terms of shape, there are 4 main types of yield curves. Each type of yield curve can inform investors about different economic conditions, making them useful indicators of future developments.
The examples below are for illustration purposes only, so don't worry too much about the values. Focus on the different shapes of the curve and the typical interpretations of that curve.
Normal yield curve
This curve slopes upward, meaning long-term bonds have higher yields than short-term bonds. It indicates that investors are expecting stable economic growth. When the curve is normal, long-term bonds can provide good returns, and stable prospects will benefit stocks, cryptocurrencies, and other growth-focused investments.
Inverted yield curve
An inverted yield curve slopes downward, where short-term yields are higher than long-term yields. Historically, this has been a warning sign of a recession. This can be a warning sign for stock investors to consider restructuring their portfolios towards safer assets like bonds.
Flat yield curve
A flat yield curve has almost no slope, with short-term and long-term yields being very similar. This indicates economic uncertainty or a transitional phase. A flat curve reflects instability, prompting investors to be more cautious when diversifying into multiple assets.
Steep yield curve
A steep yield curve forms when long-term yields rise significantly compared to short-term yields, often indicating expectations of economic growth and increasing inflation. When the yield curve is steep, it is often a signal to invest in riskier assets, such as cryptocurrencies and stocks, as a steep curve typically signals positive growth prospects.
Gradually steepening yield curve
A gradually steepening yield curve occurs when the difference (or spread) between short-term and long-term bond yields increases. It describes changes occurring on the yield curve over time (for example, when comparing the yield curves of two different years).
Types of gradually steepening yield curves
There are many types of gradually steepening yield curves, but the two main types are steepening and flattening.
Steepening: When short-term bond yields decrease more than long-term yields. This can occur when central banks cut short-term interest rates to stimulate the economy, but long-term rates remain stable, reflecting growth expectations. The green dashed line represents the yield curve after the change.
Downward slope: In this case, long-term yields rise faster than short-term yields, often because investors expect stronger economic growth or higher inflation in the future. The red dashed line represents the yield curve after the change.
Using the yield curve in financial markets
The yield curve can be a useful tool for predicting changes in interest rates, which can affect many types of assets. For example, when the curve inverts, the U.S. Federal Reserve and other central banks may lower interest rates to prevent economic recession, often boosting the market in the short term. Traders and investors can take advantage of these interest rate changes to enter or exit certain markets and adjust their bond holdings.
Bond market
Since the yield curve is directly related to bond yields, any changes can cause bond prices to fluctuate. Rising interest rates (usually associated with an upward sloping yield curve) often cause existing bonds to lose value because new bonds will offer higher yields. Conversely, if interest rates fall, older bonds with higher yields will become more valuable.
Stock market
The yield curve can affect all types of stocks, especially in interest-sensitive sectors such as banking, real estate, and utilities. For example, when the yield curve inverts, indicating the possibility of an economic recession, investors may pull out of stocks and seek safer investment channels. Additionally, a steep yield curve can signal strong economic growth, thereby boosting confidence in the stock market.
Interest rates
Changes in yield are often used as a benchmark for mortgage rates, bank lending rates, and other types of debt. When the yield curve inverts, it often acts as a catalyst for the Fed to lower interest rates to stimulate the economy, which can impact borrowing costs for consumers and businesses.
The yield curve and the cryptocurrency market
Although primarily related to traditional markets, the yield curve is also beginning to impact the cryptocurrency market in interesting ways, especially as cryptocurrency assets increasingly appear in institutional portfolios.
More and more investors and money managers are adding bitcoin and other cryptocurrencies to their portfolios.
While it is true that the increasing adoption has made the cryptocurrency market operate quite similarly to stocks, some investors view bitcoin as a form of digital gold—especially when traditional markets face instability. For example, if the yield curve inverts and recession fears rise, some investors may choose to increase their investments in assets like gold and bitcoin, which are considered ideal assets for "storing value."
Additionally, the decision to lower interest rates in line with the central bank's yield curve often increases liquidity in the financial system, and this liquidity can flow into the cryptocurrency market. This additional liquidity can boost demand for cryptocurrencies, potentially driving prices higher.
Although it can provide cryptocurrency investors with useful information, the yield curve does not apply in the same way as traditional assets. Cryptocurrencies remain highly speculative and can be influenced by many other factors such as regulatory news and technological developments. Thus, while the yield curve can provide context, experienced cryptocurrency investors often rely on a broader set of indicators.
Summary
Whether you are a traditional investor or just exploring cryptocurrencies, the yield curve is a useful tool that you should pay attention to. The yield curve not only suggests the direction of the economy but also helps investors plan strategically for various asset types.
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