What does an inverted yield curve usually signal?

An inverted yield curve typically signals a potential recession. When the yield curve is inverted, it means that short-term interest rates are higher than long-term rates, which is an unusual situation indicating that investors expect weaker economic conditions in the future. This expectation can lead to reduced borrowing and spending, and historically, an inverted yield curve has often preceded economic recessions as it reflects pessimism about economic growth.

An overheated economy, characterized by high demand and inflation, would not lead to an inverted yield curve, as short-term rates would generally be lower than long-term rates during such conditions due to increased borrowing costs. Similarly, a stimulating economy would display a normal upward-sloping yield curve reflecting investor confidence and growth prospects, while confidence in market stability would typically keep long-term rates higher than short-term rates.

Thus, the most accurate interpretation of an inverted yield curve is that it is an indicator of a potential recession, reflecting a shift in investor sentiment towards caution in the face of economic uncertainty.