A flat yield curve occurs when there is little difference between the interest rates on government bonds for different maturities. For example, the rate on the one month bond might be similar to that of the 3 month or 1 year bond as illustrated in the chart below.
A flat yield curve is a sign that the market expectation is that interest rates will remain constant for the foreseeable future. This generally occurs when an economy slows down and often is the first indication of the beginning of a recession. For example, the U.S Yield curve has been relatively flat for the past year indicating that countries difficulties. It was also flat in the early 1990s as well, coinciding with another major slow down in the U.S economy.
Estimating the future of interest rates for a given country is an important input into the future direction of that country’s currency vs. the other major cross currencies. For more information on this please read our article on How do changes in interest rates affect foreign exchange rates?
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