By Schwab Center For Financial Research, April 01, 2019
Why the yield curve matters.
A normal yield curve slopes upward from shorter maturities to longer ones. Investors usually require extra return to tie up their money for longer periods.
The slope can change when the Federal Reserve raises short-term rates to slow economic growth and curb inflation, while long-term rates may fall if markets expect lower growth and inflation.
If the Federal Reserve raises rates too quickly, short-term yields may actually move higher than long-term yields, leading to an inverted yield curve.
When a yield curve inverts, lending may become less profitable for banks because they tend to borrow at short-term rates and issue loans at longer-term rates… and tighter bank lending standards may lead to an economic slowdown as it becomes more difficult for consumers and businesses to borrow for big purchases.
Investors worry because recessions have historically been preceded by an inverted yield curve, but an inversion doesn’t necessarily mean a recession is imminent.