From SCORE Richmond by Doug Carleton:
The yield curve has inverted before every recession since 1955. So what is it? It is simply when interest rates on short-term U.S. Government bonds are higher than the interest rates paid on long-term bonds. When this happens it’s called an inverted yield curve. Sometimes it has happened months before, sometimes two years or more. But it has now happened again.
Think about deposits in a bank account, which are essentially loans to the bank. You are “loaning” your money to the bank in return for interest on that money. If you can withdraw the money at any time the bank pays you a lower rate because they may not have the opportunity to use it for very long. But if you lock up your money for a longer period – for example a 12-month CD, the bank pays you a higher interest rate because they have longer to use that money to make loans.
So when interest rates are higher on short-term bonds than long-term bonds it indicates that investors are looking at the safety of long-term bonds because they are worried about the near-term economic prospects, and because of this the government is having to pay more to short-term investors in order to sell bonds and less to long-term investors. Recession still seems to me to be too strong a word for what is coming. The labor market is strong, wages are still rising, plenty of jobs are still available for people who want them and consumers are spending like they don’t have a care in the world. So a slowdown seems much more likely than any serious recession, and more and more signs are pointing toward a slowdown. It is on the way. When, nobody knows.