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Negative Yield Curve

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A negative yield curve has short-term rates, or yields, higher than the most long-term yields. A negative yield curve is an abnormal condition. Bank margins get squeezed when a negative yield curve emerges. The negative yield curve occurs because the market sets long-term yields, but the Fed has significant control over short-term yields. The usual explanation for how the negative yield curve can persist when the Fed drives up short-term yields is that investors expect long-term yields to become even lower in the future, so they lock up money at the best rate available, negative yield curve or not. Bond market participants expect falling long-term yields despite a negative yield curve when they anticipate an economic slowdown. The bond market is usually right. Since the 1960s, almost every negative yield curve instance, of which there have been over a dozen so far, has been followed by a recession. Some analysts speculate the significance of the negative yield curve as a recession predictor may be diminishing because structural factors such as globalization are changing the market forces driving long-term yields.

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