It's nice to see the yield curve making the mainstream headlines this past week. As the short-term rates move up and long-term rates move down, the yield curve flattens, taking us closer to the scenario of an inverted yield curve. A flat yield curve, or inversion (when short-term rates rise above long-term), almost always signals troubling economic times. Below is an upward-sloping yield curve.

From the CNN Money piece:

Jim Grant of Grant's Interest Rate Observer newsletter said that when there's a large gap between short- and long-term rates, conditions are ripe for financial services firms to make money by extending credit. That in turn fuels economic activity.

"In the opposite condition, when short-term rates are on par with or higher than long-term rates, it sucks oxygen from the financial economy," he said. "It deprives lenders of profitable operations, and it discourages capital creation."

......Some economists also argue that several unique factors are contributing to low long-term rates, including slow growth in many economies overseas, a flight to quality in the bond market after GM's bonds got cut to junk, and big purchases of Treasuries by foreign central banks.

Here's a Slate piece on the yield curve, and some analysis by Tyler Cowen. Cowen, I believe, is too hasty in his assessment of the meaning of the inverted curve. Paul Cwik's excellent dissertation on this brings home the relationship between inverted yield curves and recessions. In regards to the treasuries being gobbled up overseas, more on that later.