What does an inverted yield curve indicate?

An inverted yield curve indicates that short-term yields are greater than long-term yields. This phenomenon occurs when investors expect economic slowdown or recession, leading them to seek the safety of long-term bonds despite their lower yields. As demand for long-term bonds increases, their prices rise, causing yields to fall. Conversely, if short-term rates rise—often due to central bank rate hikes or market expectations of quicker economic deterioration—the result is an inverted curve, where short-term rates surpass long-term rates.

This inversion is seen as a warning sign about the economy's future trajectory, as historically, it has often preceded economic recessions. In contrast, scenarios such as steady interest rates or high inflation expectations would typically maintain or increase the long-term yields relative to short-term yields, thus not supporting the condition described by the inverted yield curve.