Why does the interest rate on my mortgage change when the Fed makes an announcement?
Background
Interest rates are the connective tissue of macroeconomics. They link monetary policy to investment decisions, saving behavior, asset valuations, and exchange rates. The yield curve compresses a vast amount of information about the economy's expected future into a single shape.
The inverted yield curve's track record as a recession predictor is one of the most robust empirical regularities in macro. Understanding why it works -- and when it might not -- is essential for anyone tracking the business cycle.
What it covers
The yield curve plots interest rates across maturities from overnight to 30 years. Normally it slopes upward: longer maturities carry higher yields to compensate for duration risk and uncertainty. When the curve inverts -- short rates exceeding long rates -- it has historically preceded recessions with remarkable regularity.
The expectations hypothesis says long rates equal the average of expected future short rates plus a term premium. When markets expect rate cuts (typically because they expect a recession), longer yields fall below shorter yields, inverting the curve.
Open question
What is the yield curve telling you about the market's expectations for growth, inflation, and policy -- and how much of the signal is expectations vs. term premium?