The yield curve is an important barometer of economic health and market sentiment within the fixed-income space. While professionals use it to interpret expectations around future interest rates, inflation, growth and risk premiums, retail investors can also draw meaningful cues from its movements when deciding among fixed deposits, debt mutual funds or bonds.
A yield curve plots bond yields against their maturities, with short-term securities on one end and long-term instruments on the other. The vertical axis shows the yield, while the horizontal axis represents the time to maturity. Under normal market conditions, the curve slopes upward, reflecting the typical expectation that investors require higher returns for holding long-term debt.
In India, the yield curve is generally constructed using central government securities such as Treasury Bills maturing in 91, 182 and 364 days, and dated government securities (G-secs) ranging from 1 to 50 years. The curve is dynamic and shifts in response to monetary policy, inflation expectations, demand–supply conditions and global economic developments.
The yield curve also helps determine the spread between G-secs and other instruments such as State Government Securities (SGS), PSU and corporate bonds of similar maturities. This spread represents the additional credit or risk premium investors demand over risk-free government securities.
Types of yield curves
A normal, upward-sloping yield curve signals optimism. It indicates that the economy is expanding, inflation expectations are moderate and long-term borrowing costs reflect appropriate risk premiums. However, the curve does not always maintain this shape. It can steepen, flatten or invert, with each change conveying distinct information.
Steepening yield curve
A steepening yield curve occurs when the gap between long-term and short-term interest rates widens. This may happen through bull steepening, where short-term yields fall more sharply than long-term yields due to monetary easing, or through bear steepening, where long-term yields rise significantly, typically on inflation fears. A steeper curve often points to confidence in economic growth, expectations of future rate hikes or higher anticipated inflation.
A clear instance of bull steepening took place toward the end of 2020, after the Covid-19 shock, when the RBI infused liquidity and cut the repo rate by 115 basis points to boost the growth. Short-term yields such as the 91-day T-bill fell by 210 basis points to 2.92 per cent in eight months, whereas 30-year G-sec yields declined by only about 80 basis points. The current environment offers another example of steepening, driven by expectations of strong economic growth and increased government borrowing at longer maturities, alongside surplus liquidity. As of December 3, the 91-day T-bill yielded 5.35 per cent, while the 30-year G-sec traded at 7.3 per cent.
Surplus liquidity reduces borrowing costs and pulls down short-term yields, while the heavier issuance of long-maturity bonds prompts investors to seek higher returns to absorb the increased supply.
Flat yield curve
A flat yield curve emerges when short- and long-term yields converge, signalling uncertainty or a transitional economic phase. Markets may be uncertain about whether growth will strengthen or slow, and monetary policy direction may be unclear.
A notable instance occurred in March 2024, when inflation remained sticky at around five per cent, liquidity conditions were tight and the RBI held the repo rate steady after raising it by 250 basis points from 4 per cent to 6.5 per cent. Growth concerns also persisted, as GDP had then moderated to 5.4 per cent in Q2 FY24. These factors created uncertainty about how long elevated interest rates would persist, with both short- and long-tenor bonds trading near the 7 per cent mark.
Inverted yield curve
An inverted yield curve, where short-term yields exceed long-term yields, is generally viewed as the most concerning curve shape. Historically, inversions precede economic slowdowns or recessions, as they signal that markets expect interest rates to fall in the future due to weakening growth.
Although there were moments when 1-year G-sec yields briefly exceeded 10-year yields, a fully inverted curve occurred in August 2013 during the US taper-tantrum episode. Heavy foreign outflows weakened the rupee sharply, prompting the RBI to tighten short-term liquidity aggressively to stabilise the currency. This pushed money-market and short-tenor G-sec yields into double digits, while long-term yields rose far less because markets expected the measures to be temporary. The result was a rare policy-driven inversion reflecting liquidity stress rather than recession fears. On August 30, 2013, the 91-day T-bill yielded 11.2 per cent, while 10-year and 29-year G-secs stood at 8.6 per cent and 9.1 per cent, respectively.
Why should retail investors care?
For retail investors, the yield curve is a practical tool for navigating interest rate cycles. A steepening curve may indicate that rates are likely to rise, suggesting it may be advantageous to lock into long-term fixed-rate instruments before yields increase further. Long-duration bond funds suit investors with a moderate risk profile, while conservative long-term investors may consider RBI Floating Rate Savings Bonds or the Senior Citizen Savings Scheme.
An inverted curve suggests that interest rates may fall, favouring short-term or floating-rate products such as money market funds, low-duration funds and floating-rate funds.
A flat curve warrants caution and diversification, potentially through a laddering strategy that distributes investments across different maturities to balance risk and return. Short-duration funds can also be suitable in such periods.
While yield-curve datasets are not extensively available in the public domain, several mutual fund houses, such as UTI Mutual Fund in its monthly fixed-income insights, and primary dealers such as STCI PD in their daily and weekly research reports, publish relevant analyses that investors can refer to.
Published on December 6, 2025
