The yield curve is nearing an inverted position meaning short-term interest rates are higher than long-term interest rates. According to classic market thinking, this is a sign of an economic slowdown. Below I will explain why.
Here are some basic concepts you need to know
First, Let me explain a bit about the yield curve. Ideally, the curve is supposed to have lower rates for short-term maturities and higher rates for longer-term maturities. The reason is actually pretty simple. Supposed you lend someone $100 for a year. Assuming that person has good credit, you would expect there to be a pretty high probability of the borrower paying you back; there isn't much that can go wrong in a year. Now, suppose you lend the same person the same amount of money but for 30 years. The possibility is higher of things going wrong over a longer period of time. Therefore, you charge the borrower a higher rate of interest.
Secondly, inflation eats away at the interest people make on a fixed-income investment. The real rate of return for a bond is the interest rate minus the rate of inflation. In correlation, inflation has a higher chance of occurring in an expanding economy than a contracting economy.
Third, a bond's price and yield move in inverse directions. (The reasons are a bit complicated; just trust me on this one).
OK....here are the actual mechanics of what is happening right now in the bond market.
The Fed is raising short-term rates. They have been doing this for the last 13 months.
Long-term rates (from the 10-year Treasury) have fluctuated between 3.9% in late-May/early June and 4.65% in early November. One of the main reasons for various movements in the 10-year is trader's perception of inflation. As inflation fears rise, people sell long-term bonds; as inflation fears decrease people buy long-term bonds. The latest inflation numbers have been very tame. In addition, oil has dropped almost 20% since late August/early September. Because energy inflation was a big concern for most market watchers/traders, this drop is a sign energy inflation may not be as pronounced as originally thought.
So, we have the fed raising short-term rates and the longer-term market players buying long-term bonds because inflation appears to be tamer than thought. As a result, short-term rates are rising, long-term rates are falling and a yield curve inversion is pretty close to happening.
Now, the $64,000 question: is this a sign of an economic slowdown or is it more the result of purely technical factors playing out in the market.
The answer is I don't know. The primary reason why I don't know is the energy related inflation situation, which could be more stimulative than restrictive on economic growth. Lower energy prices = higher economic growth. When you compare this inflation situation to a more tradition inflation such as demand-pull inflation, it just doesn't have the same predictive power. So, in short, we'll have to wait and see.