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Foreign. Hi, I'm Andy Tempte and welcome to Money Lessons. Join me every Saturday morning for bite sized lessons that are designed to improve financial literacy around the world. Today is February 21, 2026. Last week we examined what happens when bond credit ratings fail. From Penn Central in 1970 to Enron in 2001 to to the mortgage securities disaster of 2008, we learned that bond credit ratings are useful tools, but imperfect ones, and that investors must always exercise independent judgment. Today we're exploring another tool that investors and economists watch very closely. The yield curve. You may have heard news anchors or financial pundits mention an inverted yield curve with ominous undertones. But what exactly is the yield curve? What shapes can it take? And what might those shapes be telling us about the economy? So what is the yield curve? Well, back in our January 24 episode on bond yields, we discussed yield to maturity, the total annualized return an investor earns by holding a bond until it matures. The yield curve takes this concept and plots it against different time horizons. So imagine drawing a simple graph on the horizontal axis. Place time to maturity from short term treasury bills maturing in three months all the way out to 30 year treasury bonds on the vertical axis. Plot the yield for each maturity. You connect those dots that you have on the page and voila, you have a yield curve. Now why are we using treasury securities? We do that because they carry minimal credit risk. They are backed by the full faith and credit of the United States government. This means that the curve reflects pure time preferences and expectations without the complication of the credit spreads that we've discussed in earlier episodes. So what's the normal curve? Under typical economic conditions, the yield curve slopes upward. From left to right, short term bonds yield less than long term bonds. And this makes intuitive sense. When you lend money for 30 years instead of three months, you're taking on more risk. Economic conditions could change dramatically. Inflation could erode your returns. Interest rates could shift in ways that make your locked in long term rate look less attractive. Investors naturally demand compensation for these uncertainties. A higher yield for longer commitments. That's why an upward sloping yield curve is considered normal. Now, a steep, upwardly sloping curve can signal different things depending on the context. Sometimes it reflects optimal about future growth. But a steep, upwardly sloping curve can also appear when the Federal Reserve has cut short term rates to stimulate a struggling economy. Now let's talk about a flat curve. Sometimes the curve flattens. Yields across different maturities converge towards similar levels. A flat curve often signals a transition period. The economy may be shifting from growth to slow down or vice versa. Think of a flat curve as the market expressing uncertainty. Investors aren't quite sure whether conditions will improve or deteriorate. It's kind of a holding pattern waiting to see which direction things will break. Now we talk about the third type of curve, the inverted curve. And here's where things get interesting and historically significant. An inverted yield curve occurs when short term yields exceed long term yields. The curve slopes downward from left to right. Why would investors accept lower yields for locking up their money for longer time horizons? The answer lies in expectations. If investors believe economic conditions will deteriorate deteriorate that a recession is coming, they expect the Federal Reserve to cut interest rates. In response. They're willing to lock in today's long term rates even if those rates are lower than current short term rates because they expect rates will be even lower in the future. An inverted yield curve reflects pessimism about near term economic prospects. Now here's what makes the inverted yield curve so closely watched. It has preceded every U.S. recession since the 1970s. The yield curve inverted before the recessions of 1980-1981-1982-1990, 1991, 2001 and 2007 to 2009. The 2007 inversion offers a particularly instructive example. The yield curve first inverted in early 2006, roughly 22 months before the Great Recession officially began in December of 2007. Investors who recognized this signal had nearly two years of warning before for the worst economic downturn since the Great Depression. The Great Recession lasted 18 months, the longest since World War II. Real gross domestic product fell 4.3%. Unemployment doubled from 5% to 10%. Home prices dropped approximately 30% from their peak. Those who heeded the yield curve's early warning had time to adjust their portfolios and prepare for conditions ahead. But before you rush to restructure your investments every time the yield curve inverts, some important caveats are in order. First, the timing is highly variable. The lag between inversion and recession has ranged from just a few months to nearly two years. Knowing that a recession might be coming doesn't tell you precisely when it will arrive. Second, the yield curve is one signal among many. No single indicator not the yield curve, not employment data, not consumer confidence surveys can predict the future with certainty. And third, and you'll hear this a lot correlation is not causation. The yield curve doesn't cause recessions. It reflects market expectations about future conditions. Those expectations can be wrong. And economic circumstances can change in ways that no one anticipates. The brief 2020 recession offers a humbling example. The yield curve had inverted in 2019, and a recession did follow, but it was triggered by a global pandemic that no economic indicator could have predicted. The timing may have been large, coincidental. Why does this matter? For you and for investors, understanding the yield curve helps you interpret financial news more intelligently. When commentators discuss curve steepening or flattening, you'll understand what they mean and why it matters. More practically, the shape of the yield curve affects decisions about bond investing. In a steep curve, upwardly sloping curve environment, long term bonds offer meaningfully higher yields but also more interest rate risk, as we'll explore in future episodes. In a flat or inverted environment, the extra yield from extending maturities may not justify the additional risk. The yield curve also affects the broader economy through bank lending. Banks typically borrow short term and lend long term when the curve is steep and upward sloping. This spread is very profitable for banks. When the curve flattens or inverts, bank profits typically compress and lending often tightens, which can contribute to the very economic slowdown the curve is signaling. Now we've built a substantial foundation in how bonds work, from mechanics and yields to credit ratings and market signals. Next week we're going to tackle the concept of duration, a concept that measures how sensitive a bond's price is to changes in interest rates. Until next week, I wish you grace, dignity and compassion. My name is Andy Tempte. This is Money Lessons. You can find the show on all the major streaming services as well as out on YouTube. Please like subscribe, rate and most importantly, share this public good with your friends, your neighbors, your colleagues, and maybe a family member. The show is produced by Nicholas Tempte, and we'll see you next time on Money Lessons.