How does the yield curve impact lending and recessions? (loans, borrowing, interest)

[concept_fusion]

Ok, so perhaps you've heard the yield curve is flattening and may invert in the not so distant future..

As I understand it, the theory is when the yield curve inverts banks pull back on lending, causing the economy to slow down resulting in a recession. Is it true when the yield curve inverts, short term lending becomes more profitable than long term lending? Why does that cause banks to pull back on lending? Is it because the majority of lending banks do is long term loans?

Any banking experts care to shed light on this? Thank you.

Roughly, a bank will borrow at short term rates. So if the curve is inverted, that short term borrowing becomes more expensive, while the long term lending brings in less.

Now, of course, the yield curve is just one indicator and the correlation isn't 100%.

[txgolfer130]

https://www.bloomberg.com/news/artic...why-it-matters

[lchoro]

Interest rate carry trade affect lending and investing. The spread becomes unprofitable to buy/lend at long term rates and finance the activity using short-term interest rates.

There is also the currency carry trade which has been pushing down long-term yields.

Fed funds futures think interest rates in 2018 will still be below the level when the Lehman collapse occurred and more than one year into that recession.

http://www.cmegroup.com/trading/inte...n-to-fomc.html

[FrankMiller]

Banks exist to convert (short-term) savings account deposits into (long-term) loans. They make money on the difference between the long-term rates and short-term rates.