Read the yield curve's slope as a signal about the economy, and explain how it reflects the combined stance of monetary and fiscal policy
The idea
A steep curve signals expected recovery and rising rates; a flat or inverted curve signals expected slowing, and inversions have tended to precede recessions because markets expect policy easing ahead. The policy mix maps onto the curve: easy monetary and easy fiscal policy give a steep curve; easy monetary with tight fiscal gives a moderately steep curve; tight monetary with easy fiscal gives a flat curve; tight monetary with tight fiscal gives an inverted curve. Short rates track the central bank, while long rates embed expected future short rates, inflation expectations and a term premium affected by government borrowing. The trap is reading the slope mechanically; quantitative easing or a compressed term premium can flatten the curve without signalling recession.
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