The Yield Curve definition

The cost of borrowing, or the prevailing rate of interest usually on government bills, notes and bonds over a time horizon. The time horizon often referred to is the cost of borrowing from one day to 30-years. Due to the time value of money (i.e. increased risk of having capital returned over a longer period of time along with the effect of compound interest) a normal yield curve is positively sloped, meaning that it costs more to borrow for longer periods of time. Central banks care about the shape of the yield curve because it reflects investor confidence in current monetary and fiscal policies. The yield curve responds to policy changes and to economic data. Should investors begin to sense that monetary policy is too restrictive (the cost of borrowing is too high), the yield curve may flatten as investors discount a potential ease (or cut) in the cost of borrowing in coming months. If investors become outright pessimistic about the health of the economy, they may push down the cost of borrowing at longer-dated maturities banking on a strong likelihood that the central bank will very likely be forced to reduce the cost of borrowing to counter deflation and/or a slowdown in the economy.

The Yield Curve

Trading Term

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