1) Why does inverted yield curve predict recession?

Question

1) What is the average lag time?
2) Why is the reveral to +vely sloped curve troublesome for asset markets?

Answer 1

1) An inverted yield curve occurs when long-term yields fall below short-term yields. Under this abnormal and contradictory situation, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. An inverted curve may indicate a worsening economic situation in the future. In addition to potentially signaling an economic decline, inverted yield curves also imply that the market believes inflation will remain low. This is because, even if there is a recession, a low bond yield will still be offset by low inflation. However, technical factors, such as a flight to quality or global economic or currency situations, may cause an increase in demand for bonds on the long end of the yield curve, causing long-term rates to fall. This was seen in 1998 during the Long Term Capital Management failure when there was a slight inversion on part of the curve.
2)
Historically, the 20-year Treasury bond yield has averaged approximately two percentage points above that of three-month Treasury bills. In situations when this gap increases (e.g. 20-year Treasury yield rises relatively higher than the three-month Treasury yield), the economy is expected to improve quickly in the future. This type of curve can be seen at the beginning of an economic expansion (or after the end of a recession). Here, economic stagnation will have depressed short-term interest rates; however, rates begin to rise once the demand for capital is re-established by growing economic activity.

Answer 2

If interest raise are lower for loans of a longer duration a prediction about the future has been made. This prediction may be that a recession is coming or it could be an exchange rate phenomenon or an inefficiency in the economic equilibrium. It is also a prediction that could be offset by geopolitical events, action by the central banks, technological breakthroughs or government intervention.
When you think or asset markets, think the reverse of dollar cost. Instead of dollars per asset compare asset to dollars.

Answer 3

inverted curve means people expect interest rates to drop in the future.