The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.
But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down.
On this, my second grandson's 12th birthday, I am posting a quote originating from his older brother's (my eldest grandson) 12th birthday. How often do you get a chance like that?
Before clicking the quote link, would you like to play "guess the economist?"
Here's a hint. It's not Scott Sumner.
Anyway, 18 months later, though late arriving back in the day, it's still relevant.
H/T to Delong.