Yield Curves

The most important chart in finance—and how to trade it.

Why the Yield Curve Matters

In August 2019, the 2-year Treasury yield briefly exceeded the 10-year yield. Headlines screamed "Recession Signal!" The curve had inverted for the first time since 2007.

Six months later, COVID triggered a global recession. The curve was right—again.

The yield curve has predicted every U.S. recession since 1955, with only one false positive. It's not magic—it reflects the collective wisdom of millions of market participants betting on the future. When short-term rates exceed long-term rates, markets are signaling that they expect the Fed to cut rates because the economy is weakening.

For traders, the curve isn't just a recession indicator—it's where the money is. Curve trades (steepeners, flatteners, butterflies) are among the most common positions in fixed income. Understanding curve dynamics is essential.

Historical Examples

Learn from history. Select a pivotal moment to see the curve shape and what happened next:

Pre-Crisis Inversion

2s10s: +9 bps

The Setup

The yield curve inverted as the Fed raised rates to 5.25%. Housing market was peaking. Most dismissed recession concerns.

What Happened Next

The Great Financial Crisis began 18 months later. Those who heeded the inversion signal avoided massive losses.

The Three Things the Curve Tells You

Where the Fed is Going

The front end (2Y and shorter) is dominated by Fed policy expectations. When 2Y yields rise sharply, markets expect hikes. When they fall, cuts are coming.

Real example: In March 2022, 2Y yields jumped from 0.7% to 2.3% in weeks as markets priced in the Fed's hiking campaign. Traders who were short 2Y made fortunes.

Growth & Inflation Expectations

The long end (10Y, 30Y) reflects where markets think growth and inflation are headed. Rising long yields = optimism. Falling long yields = pessimism or flight to safety.

Real example: During COVID's March 2020 panic, 10Y yields fell to 0.5%. Investors were willing to accept almost nothing for 10 years just to be safe.

The Economic Outlook

The spread between short and long rates (2s10s, 5s30s) captures the market's view of the economic trajectory. Steep = optimism. Flat/inverted = concern.

Real example: The 2s10s spread reached -80bps in November 2022—the deepest inversion since 1981. Every major bank was predicting recession by mid-2023.

How Traders Use the Curve

Every rates trader has a view on the curve. Here are the classic trades:

Steepener

Long the long end, short the short end (e.g., long 10Y, short 2Y)

When to use: You expect the curve to steepen—either because short rates will fall (Fed cutting) or long rates will rise (inflation/growth expectations).

Best recent setup: January 2021. Vaccines rolling out, stimulus checks coming. Steepeners were the consensus trade—and they worked. 2s10s went from 80bps to 160bps in two months.

Flattener

Long the short end, short the long end (e.g., long 2Y, short 10Y)

When to use: You expect the curve to flatten—Fed hiking (pushes short rates up) or growth concerns (pulls long rates down).

Best recent setup: Late 2021 into 2022. Inflation was surging, Fed pivot was coming. 2s10s collapsed from 130bps to negative. Flatteners crushed it.

Butterfly

Long the belly, short the wings (e.g., long 5Y, short 2Y and 10Y)

When to use: You think the middle of the curve is cheap relative to the ends, or you want curve exposure without directional risk.

Why it matters: Butterflies are how traders express views on curve curvature, not just slope. They're also used to monetize specific Fed meeting expectations.

Build Your Curve Trade

Load:

Trade Legs

No legs added. Click "Add Leg" or select a preset strategy above.

The Carry Dimension

Curve shape determines carry. In a steep curve, you earn positive carry being long duration—your coupon exceeds your financing cost. In an inverted curve, you pay to be long—negative carry bleeds your P&L every day.

Steep Curve (2021)

10Y yield: 1.5% | Repo: 0.05%

Carry: +145 bps/year

Being long duration pays you while you wait.

Inverted Curve (2023)

10Y yield: 3.8% | Repo: 5.3%

Carry: -150 bps/year

Being long duration costs you every day. You need rates to fall just to break even.

This is why inverted curves are hard to trade. You might be right about direction, but the negative carry can kill you if timing is wrong.

Trade Examples (Simple)

Three real-world examples showing how curve trades work in practice:

Example 1: The Steepener

The Trade: You buy $10M of 10-year Treasuries and short $20M of 2-year Treasuries (duration-weighted)

What Happens: Fed signals rate cuts. 2-year yield drops from 4.5% to 4.0%, 10-year only drops from 4.3% to 4.1%

Your P&L: Short 2Y gains ~$200K, long 10Y gains ~$160K = +$360K total

How It's Funded: For the long 10Y, you put up $500K margin (5%) and borrow $9.5M via repo at 5.3%. For the short 2Y, you borrow the bonds via reverse repo and sell them for $20M cash, which you invest at repo rate. Your actual capital at risk is ~$1M, but you control $30M of bonds. This is 30x leverage.

Plain English: You bet the curve would steepen. Short rates fell more than long rates. You won on both legs.

Example 2: The Flattener

The Trade: You buy $20M of 2-year Treasuries and short $10M of 10-year Treasuries

What Happens: Inflation spikes, Fed hikes aggressively. 2Y rises from 2% to 4%, 10Y rises from 3% to 4%

Your P&L: Long 2Y loses ~$760K, short 10Y gains ~$800K = +$40K (barely profitable, high stress)

How It's Funded: For the long 2Y, you put up $400K margin (2%) and borrow $19.6M via repo. For the short 10Y, you borrow bonds via reverse repo, sell them for $10M, and invest the cash at repo rate. When you close, you buy bonds back and return them. Total capital: ~$600K controlling $30M. Leverage: 50x.

Plain English: You bet the curve would flatten. It did, but both rates rose so much your long leg hurt. Barely made money.

Example 3: The Butterfly

The Trade: You buy $20M of 5-year, short $10M of 2-year, short $10M of 10-year

What Happens: The belly richens - 5Y yield drops 20bps while wings stay flat

Your P&L: Long 5Y gains ~$180K, shorts break even = +$180K

How It's Funded: For the long 5Y, you put up $600K margin (3%) and borrow $19.4M via repo at 5.3%. For both shorts, you borrow bonds via reverse repo, sell them for $20M total, and earn repo rate on that cash. Your capital at risk is ~$800K controlling $40M in positions. This is 50x leverage.

Plain English: You thought 5-year was too cheap vs the wings. The market agreed. You made money when the belly caught up.

Learn About Carry → Or: Roll-Down Returns