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Monday, 19 August 2019

The inverted yield curve: An explainer

There has been a lot of chatter about the inverted yield curve lately: The inverted yield curve is an infamous predictor of US recessions, having occurred before every downturn since 1950 (apart from one). And last week the alarm began to ring again, setting off fevered speculation in the financial press about whether the US economy is about to sink into a recession. For those of you who don’t know what an inverted yield curve is and why you should care about it, the Economist’s Wall Street correspondent Alice Fulwood is on hand to explain (watch, runtime: 4:15).

Put in the simplest possible terms: The yield curve is a graph which measures the returns investors receive from government bonds with different maturities. The x-axis measures time, and the y-axis the interest rate (or yield) received on each bond. It is typically upward-sloping, indicating that bonds with longer maturities have a higher interest rates. This is because investors would, under normal circumstances, demand higher returns for locking up their cash for longer periods of time. If prevailing economic expectations take a turn for the worse, the interest rates on longer-term bonds can fall below those on short-term bonds, causing the curve to become downwards sloping. This is what economists refer to when they say “a yield curve has inverted.”

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