What does an inverted yield curve indicate?

An inverted yield curve occurs when short-term interest rates are higher than long-term interest rates. This situation typically indicates a spread that is less than zero, which is the significant characteristic of an inverted yield curve. When the yield curve inverts, it often suggests that investors expect a slowdown in economic growth or a potential recession, leading them to seek the relative safety of long-term bonds despite their lower yields.

The inversion reflects pessimism about the economy's future, with investors favoring long-term securities, thereby driving down their yields. The critical point is that an inverted yield curve has historically been a reliable predictor of impending economic downturns. Understanding this relationship is essential for market technicians and investors as it helps them gauge market sentiment and potential economic conditions.