Why Does the Yield Curve Typically Invert before Recessions?

Inversions of the Treasury yield curve, which occur when shorter-term securities have higher interest rates than longer-term ones, have preceded the past seven recessions. But why does the yield curve tend to invert before a recession hits?

In this video, taken from a recent Dialogue with the Fed presentation, St. Louis Fed Director of Research Chris Waller discusses two reasons why: if people expect real interest rates to fall (which is usually viewed as a pessimistic outlook for the economy) and/or if they expect inflation to fall. He also emphasizes that a yield curve inversion doesn’t cause anything; it’s simply a signal.

Additional Resources

• Dialogue with the Fed: Staying Ahead of the Yield Curve
• On the Economy: Which Groups Recovered Their Wealth after the Great Recession?
• On the Economy: Japan’s Lost Decade vs. the US Great Recession