EXPLAINER: Why bond yields may be warning of a recession

NEW YORK (AP) — One of the more reliable warning signals for an economic recession is starting to shine.

The “yield curve” is watched for clues to how the bond market is feeling about the U.S. economy’s long-term prospects. On Tuesday, a closely followed part of the yield curve gave investors some cause for concern.

WHAT IS THE YIELD CURVE?

At the center of the investing world are Treasurys, the IOUs the U.S. government gives to investors who lend it money. The yield curve is a chart showing how much in interest different Treasurys are paying.

On one end are shorter-term Treasurys, which get repaid in a few months or a couple years. There, yields closely follow expectations for what the Federal Reserve will do with overnight interest rates. On the other end of the chart are longer-term Treasurys, which take 10 years or decades to mature. Their yields tend to move more on expectations for economic growth and inflation further into the future.

Usually, longer-term Treasurys offer higher yields than shorter-term ones, resulting in a chart with an upward sloping line. That's in part because investors typically demand higher yields to lock away their money for longer, given the possibility of future rate increases by the Fed and the risk of inflation. But when investors are worried the economy will fall sharply, perhaps because the Fed is pushing short-term rates too high too aggressively, they’re willing to accept less for a Treasury maturing many years in the future.

When yields for short-term Treasurys are higher than yields for long-term ones, market watchers call it an “inverted yield curve.” And when that chart has a downward sloping line, Wall Street starts getting nervous.

WHY CARE?

All the talk about charts and yields is tough to digest, but an inversion in the...