What is the Yield Curve?

What is the Yield Curve?

The yield curve plots interest rates for government bonds from short to long maturities. Its shape embeds expectations for policy, inflation, growth, and term premia—making it a powerful macro signal for FX.

Shapes and Signals

• Normal: Long yields above short—expansion with modest inflation.
• Flat: Tight spread—transition, uncertainty, or late‑cycle dynamics.
• Inverted: Short rates above long—markets expect policy cuts and slower growth.

FX Applications

• Trade currencies with steepening curves against those still in inversion.
• Watch cross‑country 2‑year spreads; FX often follows the differential.
• Use curve shifts to time carry trades—steepening and rising reals favor high‑yielders.
• Confirm with positioning in bond futures and basis markets.

Term Premium and Near‑Term Forwards

Changes in term premium can move long yields without altering policy odds; avoid over‑attributing FX to those swings. The near‑term forward spread—expectations for policy 12–18 months ahead—often leads recession calls and FX rotations. Cross‑market confirmation from inflation breakevens and swap spreads helps distinguish policy repricing from risk‑premium shifts. Compare curves across regions; a steepening UK curve versus a still‑inverted Eurozone curve can favor GBP over EUR if supported by growth differentials.

Steepeners vs. Flatteners

• Bear steepener: Long yields rise faster—often reflationary, supportive of cyclicals and carry.
• Bull flattener: Short yields fall faster—policy‑cut pricing, typically USD‑negative vs. pro‑growth FX.
• Bear flattener: Front‑end rising on hikes—USD‑supportive vs. low‑yield peers.
• Bull steepener: Long yields fall faster—early easing with anchored cuts; FX impact mixed.

Global curves rarely move in lockstep. If the U.S. curve re‑steepens on resilient growth while Europe remains inverted on stagnant activity, USD can gain versus EUR as the policy gap widens. Combine curve signals with inflation breakevens and growth surprises to avoid false signals.

Practical tip: track the daily change in 2s/10s and 3m/10y alongside FX performance baskets. Persistent relationships reveal which currencies are most sensitive to curve dynamics in the current regime.