What does a downward sloping yield curve signify?

A downward sloping yield curve typically signifies that short-term yields are higher than long-term yields. This inversion often reflects investor sentiment regarding future economic conditions. When investors foresee slowing economic growth or potential recession, they may demand higher yields for shorter-term investments due to the increased perceived risk over that shorter duration. This leads to a situation where the yield on shorter-term bonds becomes higher than that of longer-term bonds, resulting in the characteristic downward slope of the curve.

In this context, the relationship between short-term and long-term yields is key. A downward sloping yield curve may indicate that investors are willing to accept lower long-term yields in exchange for the safety of holding long-term debt, reflecting their concerns about the economy's future performance. This is perceived as a warning sign about potential economic slowdown.