Humped Yield Curve

Definition

The financial investing term humped yield curve refers to a bell-shaped curve, indicating mid-term rates that exceed both long and short term rates.  When debt of similar credit quality, such as that issued by the U.S. Treasury Department, result in a humped yield curve it's typically interpreted as a slowing of the economy.

Explanation

Also known as the term structure of interest rates, yield curves are typically used depict the relationship between interest rates and the time to maturity of a debt security such as a bond.  The shape of the curve provides the analyst-investor with insights into the future expectations for interest rates, as well as a possible increase or decrease in macroeconomic activity.  Yield curves are simple line plots showing the term, or maturity, on the x-axis (horizontal axis) and the corresponding rate of interest, or yield, on the y-axis (vertical axis).  When plotting a yield curve, the securities should be of similar, if not identical, credit quality.

As the illustration below demonstrates, a humped yield curve at shorter maturities has a positive slope, and then a negative slope as maturities lengthen.  This results in what is also referred to as a bell shaped curve.  Humped yield curves are rare, and when debt issued by the U.S. Treasury Department results in this type of curve, it's typically interpreted as a signal the economy is slowing down.  As is the case with a flattened curve, a humped yield curve cannot be explained by market theories and is a transitional state.

For example, if the returns on five year debt were higher than two and ten year debt, individuals would not choose to invest in the longer-term security, since they are not being compensated for the additional risk they're assuming.  This lack of investor interest in longer-term debt would eventually drive their returns higher.  In the same way, investors would flock to mid-term debt, eventually driving rates down.

Example

The following illustration demonstrates the shape of a normal versus humped yield curve.

Humped Yield Curve

Related Terms

yield curve, normal yield curve, inverted yield curvesteep yield curve, flattened yield curve, backwardation, contango