Everybody says negative yield curve is bad but no one explains why that is.
Banks borrow money from the Fed, central banks around the world and other entities in the short term market and lend it to people in the long-term market. Also, the interest rates of depositors is determined by short term bond yields while interest rates of borrowers is determined by long term yields.
Basically the bank borrows money for 1% and lends it to you for 4% and makes money on the 3 percent difference. When the yield curve is zero or negative, banks can’t make money by lending money, so they stop lending money. This means less money in the system and credit crunch. If people and businesses can’t borrow, the economy can’t grow.
This also depends on how long the curve remains negative. If it dips for one day and reverses the next day it might be ok but if it is persistently negative, time to start getting worried.
If you can’t get loans you can’t buy cars, houses, mail order brides, roll your debt over…etc. That’s how it causes recession. Fed can sometimes help by lowering short term rates if they are too high but it has little room to help if short term rates are already at low levels.