Yield Curve Cheat Sheet

A practical reference for yield curve concepts, spreads, signals, and strategies.

Key takeaways

• The yield curve plots bond yields against maturity; its shape reflects investor expectations, market segmentation, and Fed policy
• Five main curve shapes: normal, flat, inverted, humped, and steep
• Two recession indicators: 2-10 spread and 3M-10Y spread; inversions have preceded every U.S. recession since 1955
• Four main trading strategies: steepeners (long long-end), flatteners (short long-end), butterflies (curve curvature), and carry trades
• Curve signals are powerful but imprecise; combine with other data (unemployment, inflation, credit spreads) for robust forecasting

The Five Curve Shapes

Shape	Characteristics	Signal
Normal (Steep)	Yields increase with maturity; 2-10 spread 50–150+ bps	Healthy growth expectations, stable inflation
Flat	Yields nearly equal across maturities; 2-10 spread near 0	Economic uncertainty, Fed near peak tightening or near trough easing
Inverted	Long-term yields below short-term; 2-10 spread negative	Recession expected within 12–18 months
Humped	Yields peak at intermediate maturity (5–7 years), then decline	Supply/demand imbalance; long-end poor bid, intermediate strong
Steep	Large spread between short and long; 2-10 spread 150+ bps	Strong recession fears, flight to long-term safety, or Fed cuts coming

Key Recession Signals

Indicator	Threshold	Lead Time	Reliability
2-Year–10-Year Spread	Inverts (0 bps); deep inversion (-100+ bps)	12–18 months	100% (every recession since 1955)
3-Month–10-Year Spread	Inverts (0 bps); Fed's preferred measure	12–18 months	100% (every recession since 1955)
Depth + Duration	Spread inverts AND stays negative for 3+ months	12–18 months	Higher severity correlated with deeper inversion

Caveat: An inversion signals elevated recession risk, not a guaranteed recession. An inverted curve in a resilient economy (as in 2023) can lead to mild or no recession if the Fed cuts rates early.

Theories Behind Curve Shapes

Theory	Key Idea	Implication
Expectations Hypothesis	Curve reflects expected future Fed policy and inflation	Inversion signals expected rate cuts, recession
Market Segmentation	Different investors cluster at different maturities; supply/demand varies per segment	Curve shape reflects habitat imbalances, not just expectations
Preferred Habitat	Investors have maturity preferences but will venture elsewhere if compensated with higher yield	Curve reflects both expectations and habitat premiums; some steepness may be "noise," some substantive

Practical take: All three theories are partially correct. Curve movements reflect expectations, investor preferences, and market supply/demand simultaneously.

Yield Curve Spreads: Quick Reference

Spread	Components	Use	Normal Range	Inversion Threshold
2-10	10-year minus 2-year	Most popular recession signal	+50 to +150 bps	< 0 bps
3M-10Y	10-year minus 3-month T-bill	Fed's preferred recession signal	+100 to +200 bps	< 0 bps
2-5	5-year minus 2-year	Short-end slope; sensitive to near-term Fed expectations	+20 to +60 bps	< 0 bps (rare)
5-10	10-year minus 5-year	Intermediate-to-long slope	+20 to +60 bps	< 0 bps (rare)
10-30	30-year minus 10-year	Long-end slope; term premium indicator	+20 to +80 bps	< 0 bps (rare)

Curve Trading Strategies

Steepener

• Bet: Curve will steepen (long yields will rise relative to short yields).
• Position: Long long-end (10Y), short short-end (2Y).
• Best after: Inversion or flat curve; Fed tightening cycle appears over.
• Risk: All yields rise, curve flattens (opposite of bet).
• Profit target: 2-10 spread widens by 30–50 bps.
• Example: 2022–2023, when the -150 bps inversion re-steepened toward 0 and positive.

Flattener

• Bet: Curve will flatten (short yields will rise relative to long yields).
• Position: Short long-end (10Y), long short-end (2Y).
• Best after: Steep curve; Fed tightening expected.
• Risk: Recession fears spike, long end rallies, curve steepens (opposite of bet).
• Profit target: 2-10 spread narrows by 30–50 bps.
• Example: Mid-2021 to mid-2022, when the +160 bps spread flattened toward inversion.

Butterfly

• Bet: Middle of curve (5-year) is rich or cheap relative to 2-10 line.
• Position: Long 2Y and 10Y, short 2x 5Y (normal); reverse for opposite bet.
• Advantage: Duration-neutral; profits from curvature, not direction.
• Challenge: Small profit margins (2–5 bps); requires tight execution and leverage.
• Best after: Supply/demand imbalance isolates the 5-year.
• Example: Professional traders constantly monitor and execute butterflies.

Carry Trade

• Bet: Curve remains steep enough to reward holding longer bonds.
• Position: Long long-end, finance with short-term funding (repo).
• Profit driver: Coupon yield (carry) + roll-down price appreciation.
• Risk: Curve flattens sharply, all yields rise, or funding costs spike.
• Profit target: 100–150 bps annual carry in a steep 2-10 environment.
• Example: 2021, when the curve was steep and carry was attractive, but profits evaporated as the Fed tightened in 2022.

Duration Play

• Bet: Overall yields will fall (bullish bond prices) or rise (bearish).
• Position: Long long-duration bonds if yields fall; short if yields rise.
• Best for: Macro conviction (recession coming → buy long bonds; inflation accelerating → sell).
• Leverage: Often high, since duration moves can be 10%+ per 100 bps yield move.
• Example: 2022 (bet against long bonds through Fed tightening) would have been profitable; 2023 (bet on long bonds as cuts came) would have been profitable early but suffered as growth held up.

Historical Inversions and Outcomes

Period	2-10 Inversion	Recession Start	Severity
1966–1967	Late 1966	December 1969	Mild
1973	Early 1973	November 1973	Severe (oil crisis)
1980–1982	1978–1980	January 1980	Severe (double-dip)
1989–1991	1989	July 1990	Mild
2000–2001	2000	March 2001	Mild (tech)
2006–2008	2006	December 2007	Severe (financial crisis)
2019–2020	2019	March 2020	Severe (COVID)
2022–2023	August 2022	(Expected late 2023–early 2024)	Moderate (defied signal through 2023)

Quick Diagnostic: What Does the Curve Tell You Now?

1. Check the 2-10 spread:

   • If > +80 bps: Curve is steep. Steepening is unlikely; flattener may appeal if growth strengthens.
   • If +20 to +80 bps: Normal. No strong signal. Carry trades make sense.
   • If 0 to +20 bps: Curve is flat. Recession risk rising. Steepener may appeal if this is temporary.
   • If < 0 bps: Curve is inverted. Recession risk elevated. De-risk equities; consider bonds hedge.

2. Check Fed policy:

   • If Fed is hiking: Expect short-end yields to rise faster than long-end. Curve may flatten.
   • If Fed is paused: Curve shape depends on growth and inflation expectations. May steepen or stay flat.
   • If Fed is cutting: Short-end yields should fall fast, potentially steepening the curve.

3. Check other indicators:

   • Unemployment: If low and falling, growth strong. Curve less likely to invert. If rising, recession risk up.
   • Inflation: If high, long-end yields may rise faster, flattening curve. If low, Fed may cut sooner, steepening.
   • Credit spreads: If widening, recession fears rising. Curve should steepen or invert. If tightening, growth expectations improving.
   • Equity markets: If stocks are strong and rallying, growth expectations intact; curve less likely to invert. If stocks weak and falling, curve likely steep or inverted.

Common Curve Misconceptions

Myth	Reality
"An inversion means recession is coming now."	Inversion signals recession risk in 12–18 months, not immediate recession.
"A flat curve is a buy signal for stocks."	Flat curve signals caution; growth may slow. Stocks often underperform bonds.
"The longer the inversion, the worse the recession."	Depth and duration of inversion are weak predictors of severity. 2022 inversion was deep but outcomes soft; 2007 was moderate but led to crisis.
"The Fed watches the 2-10 spread."	The Fed prefers the 3M-10Y spread and uses multiple indicators. No single signal drives Fed policy.
"Yield curve trading is risk-free arbitrage."	Curve trades require leverage, face execution risk, and can lose money for extended periods. They are relative-value bets, not arbitrage.

Bond Fund Tickers (For Reference)

Ticker	Fund	Maturity Focus
BND	Vanguard Bond Index	Broad bond market
AGG	iShares Core US Bond ETF	Broad bond market
TLT	iShares 20+ Yr Treasury	Long-duration
IEF	iShares 7-10 Yr Treasury	Intermediate
SHY	iShares 1-3 Yr Treasury	Short-duration
TIP	iShares TIPS Bond ETF	Inflation-protected
LQD	iShares Inv. Grade Corporate	Corporate bonds
HYG	iShares High Yield Bond ETF	Junk bonds
BNDX	Vanguard International Bond ETF	International bonds

(These are for reference; no endorsement or recommendation implied.)

Decision Tree: Choosing a Curve Strategy

Is the curve steep (2-10 > +100 bps)?
├─ Yes → Is growth strong?
│   ├─ Yes → Flattener or short duration (curve will flatten, long bonds underperform)
│   └─ No → Hold steep positions; don't initiate flatteners
├─ No → Is the curve flat or inverted (2-10 < +30 bps)?
│   ├─ Yes → Steepener or long duration (recession fears; curve will steepen, long bonds will do well)
│   └─ No → Curve is normal. Carry trade or wait for extremes.

Key Questions for Investors

1. Do I believe the recession is coming within 12 months?

   • If yes: Long bonds, short equities, steepener trades.
   • If no: Carry trade, moderate duration, normal allocation.

2. Do I believe the Fed is done tightening or will cut soon?

   • If yes: Steepener (short-end yields will fall faster).
   • If no: Flattener or stay neutral.

3. Do I have conviction on absolute yield direction?

   • If yields will fall: Long duration (long bonds).
   • If yields will rise: Short duration (short bonds).
   • If unsure: Curve-relative trades (steepener, flattener, butterfly).

4. What is my risk tolerance?

   • High: Leverage, butterflies, directional bets.
   • Moderate: Steepeners, flatteners, carry trades.
   • Low: Buy-and-hold bonds, avoid leverage and curve trades.

The Curve at a Glance

The yield curve is the fixed-income market's most important signal. It reflects collective expectations about growth, inflation, Fed policy, and risk appetite. A steep curve says "growth is good, but the long-term is uncertain." A flat curve says "growth is slowing." An inverted curve says "recession is coming." By learning to read the curve and trade its moves, investors gain both a powerful forecasting tool and a source of investment returns.

Next

This cheat sheet brings together all the concepts from Chapter 9. The yield curve is a complete financial ecosystem: a forecast, a trading playground, a signal of economic health, and a constant source of debate among investors and policymakers. Mastering the curve—understanding its shapes, its signals, and its trading mechanics—is essential for any serious fixed-income investor. The next chapter shifts from bond yields to bond credit: how to evaluate the creditworthiness of bond issuers and construct portfolios that balance yield with safety.

Related concepts

• What is the yield curve?
• The 2-10 Spread
• The 3-Month—10-Year Spread
• Yield Curve Trading Strategies