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Jared Olivenstein:

If you follow economic news, you may have come across the term "yield curve." In this video, we'll explore what a yield curve is and why we care about the U.S. Treasury yield curve in particular.

At its most basic, a yield curve depicts the relationship between a bond's lifespan and how much a bond buyer can expect to earn from it over that time.

By way of background, the U.S. Treasury issues securities to finance government projects and operations. When we buy Treasuries, we become lenders to the U.S. government.

The yield we can expect to earn is impacted by three factors: one, the face or par value of that security and its coupon; two, the price you pay for it; and three, how much time remains until its maturity date.

The par amount is what the Treasury pays you when the bond matures.

So why is the Treasury yield curve important? It's important because economists and investors often look to it as an indicator of the economy's health.

On the x-axis, we plot maturity dates—when the principal and final interest payments are made. On the y-axis, we plot yields at various maturities, such as three and six months, as well as two, five, 10, and 30 years, for example.

For short-term bonds, we usually see lower yields compared to their longer-term counterparts. That's because there is more uncertainty further into the future regarding interest rate policy and inflation.

In addition, longer-term bonds have a longer duration and therefore are more sensitive to changes in interest rates. In other words, they carry more interest rate risk, or price sensitivity to changes in yields, compared to shorter-term bonds.

On a typical U.S. Treasury yield curve, you can see it slope upward as maturity dates extend, reflecting higher yields for longer-term bonds. That's a standard, healthy-looking yield curve.

However, economic uncertainty can lead to irregularities. In certain economic environments, the yield curve may invert, meaning short-term bonds have higher yields than long-term bonds.

This usually happens when short-term policy rates become high enough that investors grow nervous about the economy. In this case, investors tend to flock to the relative safety of long-term Treasury bonds, which are backed by the U.S. government.

This increased demand drives up bond prices. When a bond's price rises, its yield declines.

Historically, inverted yield curves have been a reliable warning sign of a future recession, so they're an important metric for economists and investors.

So to recap, yield curves plot bond yields across a range of maturities. Typically, as the maturity date increases, so does the yield.

However, the yield curve inverts when short-term debt securities generate higher yields than long-term debt.

The shape of the yield curve is closely tied to the health of the economy, investor sentiment, and overall market stability.

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