What is the primary function of the yield curve in finance?

The primary function of the yield curve in finance is to assess the relationship between interest rates and time. The yield curve graphically represents the interest rates of bonds of varying maturities, typically government bonds, and shows how these rates change over time.

Investors and analysts use the yield curve to gauge economic expectations. A normal upward-sloping yield curve suggests that longer-term debt instruments have higher yields than short-term ones, reflecting the risks associated with time and the expectation of economic growth. Conversely, an inverted yield curve, where short-term rates are higher than long-term rates, might indicate a potential recession.

By illustrating these relationships, the yield curve serves as a crucial tool for predicting future interest rate changes, assessing economic conditions, and making investment decisions. This focus on maturity and interest rate differentials is what makes the relationship at the heart of the yield curve particularly important in financial markets.