When short-term interest rates exceed long-term rates — a historically reliable leading indicator of economic recession, typically occurring 12-18 months before a downturn.
Deeper Explanation
An inverted yield curve creates a negative carry environment for banks (they borrow short and lend long — inversion crimps their net interest margin), which restricts credit creation and slows economic activity. It also signals that bond markets expect the central bank to cut short-term rates in the future — because economic weakness is coming. The mechanism: when the curve inverts, banks reduce lending, businesses face tighter credit, investment slows, and the economy contracts. Every US recession since 1955 has been preceded by a yield curve inversion, though the lead time varies from 6 to 24 months. The inversion is the signal; the timing of the recession is the uncertainty.
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