Inverted yield curve

An inverted yield curve occurs when short-term bond yields rise above long-term bond yields, the reverse of the normal pattern in which investors demand more yield for tying up their money for longer. It is most commonly discussed in the context of US Treasury yields, such as when the two year Treasury yield rises above the ten year Treasury yield.

An inversion typically happens when investors expect the Federal Reserve to cut interest rates in the future, often because they anticipate a slowing economy, which pulls longer-term yields down even as short-term yields stay elevated with current policy. This pattern has preceded most US recessions over the past several decades, which is why an inverted yield curve is closely watched as one of the more reliable recession indicators available, even though the lag between inversion and an actual recession has varied considerably from one cycle to the next.

An inverted yield curve also has direct effects on markets beyond its role as a forecasting signal. It can squeeze the profitability of banks, whose business model typically depends on borrowing short-term at lower rates and lending long-term at higher rates, and it changes the calculus for bond investors, since it means holding shorter-term bonds can offer as much or more yield as longer-term ones without the added interest rate risk.