Bad news for the U.S. that is worse news for the world

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Upside-Down Interest Rates
Bad news for the U.S. that is worse news for the world.
By Daniel Gross
Posted Friday, June 3, 2005, at 3:31 AM PT

Here's a bad sign: If current trends continue, we could soon be experiencing an inversion of the yield curve.

Though it sounds like something out of quantum physics, the yield curve is actually a fairly simple concept. It describes the relationship between interest rates on long-term and short-term U.S. government bonds. Interest rates on the shortest-term bonds correlate very closely with the interest rates set by the Federal Reserve Board. Long-term interest rates, by contrast, are influenced by many more factors, ranging from China's purchase of debt to investors' optimism about inflation and growth. Typically, bonds that mature further in the future pay higher yields—compensation for the risk of locking up money for a longer period.

When the difference between long-term and short-term interest rates is large, the yield curve is said to be steep. When the difference is negligible, it's flat. But when long-term rates are lower than the short-term rates, it's inverted. (On Smart Money's great yield-curve primer, you can click through the month-by-month interactive chart to see how the curve has shifted since 1977.)