What’s the deal with that inverted yield curve? A sports analogy might help

[WASHINGTON] The financial world has been atwitter about the inversion of the yield curve. It is a phenomenon in the bond market in which longer-term interest rates fall below shorter-term interest rates, and has historically been a warning sign that a recession could be on the way.

Interest rates are closely connected to the rate of economic growth and inflation. In boom times, lots of people want to borrow money, to expand their businesses, say, or buy houses. And the Federal Reserve will raise the interest rate that it controls in order to prevent the economy from overheating, resulting in inflation. When a slowdown comes, the process works in reverse.

But if you buy a 10-year Treasury note, you're making a bet on the more distant future. The economy will probably change a lot over the next decade. You can't predict exactly what will happen, but you are betting on the general direction of things: Do you expect the economy to heat up, creating inflation pressures and causing the Fed to raise rates? Or do you expect it cool down?

Or consider the Patriots. They have been the best team in the game for the past two decades, but their quarterback, Tom Brady, is 42 years old, and their coach, Bill Belichick, is 67. It would be reasonable to expect the team to decline over the next decade after these stars retire. That's exactly what the yield curve is doing: It is telling us the difference between shorter-term and longer-term interest rates, and hence whether investors expect the economy to get better or worse in the years ahead. Our fictional Patriots yield curve is inverted, and so is the actual US Treasury bond yield curve.

It's the opposite of times like 2009, when the economy was in recession and the yield curve pointed to future improvement. At those moments, the United States more resembled the Cardinals, a bad team but with room to improve in the coming years and the tools to do it.

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