What Is a Humped Yield Curve?

A humped yield curve is unusual when medium-term fixed-income assets have more excellent interest rates than long- and short-term instruments. Short-term interest rates rising and falling will also cause a humped yield curve. Bell-shaped, humped yield curves exist.

Explaining Humped Yield Curves

The yield curve graphs interest rate yields for bonds of identical quality across time to maturity, from 3 months to 30 years. The yield curve gives investors a fast overview of short-term, medium-term, and long-term bond rates. Short-term interest rates affect the yield curve, which rises when the Federal Reserve expects to raise rates and falls when it expects to lower rates. Inflation, investor demand-supply, economic development, institutional investors trading big blocks of fixed-income securities, etc., affect the long end of the yield curve.

Analysts and investors can predict interest rate changes and macroeconomic activity based on the curve’s form. A humped yield curve is one option.

The curve gets humped when intermediate-term bond yields exceed short- and long-term bond yields. A humped yield curve has a positive slope for shorter maturities and a negative slope as maturities grow, creating a bell-shaped curve. In a humped yield curve, bonds with maturities of one to 10 years may outperform those with maturities of less than one year or more than ten years.

Humped vs. Regular Yield Curves

A humped yield curve does not pay investors for the risks of owning longer-term debt instruments, unlike a regular yield curve that rewards longer-term bond purchases.

If a 7-year Treasury note yielded more than a 1-year bill or 20-year bond, investors would choose it, leading to higher prices and lower rates. With a rate less competitive than the intermediate-term bond, investors will avoid long-term investments. This will lower the 20-year bond’s value and raise its yield.

Humps types

The humped yield curve is rare, but it indicates economic uncertainty or instability. A bell-shaped yield curve may indicate investor anxiety about economic policies or circumstances or a shift from a normal to an inverted or inverted to the standard curve. Inverted yield curves are not the same as humped yield curves, which frequently indicate declining economic development. When long-term rates fall below short-term rates, the yield curve inverts. An inverted yield curve suggests that investors expect the economy to weaken or deteriorate, which may cut inflation and interest rates for all maturities.

A negative butterfly, or humped yield curve, occurs when short-term and long-term interest rates decline more than intermediate-term rates. The intermediate maturity sector is like a butterfly’s body, while the short and long maturity sectors are its wings.

Conclusion

• A humped yield curve develops when medium-term rates exceed short- and long-term rates.
• A humped curve is rare but can emerge from a negative butterfly or a yield curve shift when long- and short-term yields decrease more than intermediate ones.
• Inverted yield curves show the reverse of typical yield curves, which start low and rise with time. Instead, humped curves are bell-shaped.