Call it "the unbearable flatness of yields" or "the trouble with the curve." However one cares to describe it, the slope of the Treasury yield curve has been the subject of much concern of late, as regards the future direction of the economy.
The yield curve — the relationship of short to long-term interest rates — can tell us much about the bond market's view of economic growth prospects.
During an economic recovery, the slope is positive, with long-term interest rates a couple percentage points above short-term rates. That's because bond market investors want more compensation, over the long haul, for lending money to government.
The reason for that is that as the economy accelerates, so too does inflation, which reduces the purchasing power of longer-term bonds. With more inflation investors demand higher yields as a means of protecting the value of their bond investments.
As the economy accelerates, the Federal Reserve, typically, begins raising interest rates to counter-act rising inflation, often to the point of tipping the economy into recession. At that juncture, long rates begin to fall as short-rates rise.
Bond investors, who are often quite prescient, fear the Fed will raise rates too much, not only killing off inflation, but also the economic growth that comes with it. Hence, the yield curve flattens and, ultimately, "inverts" to the point where long rates fall below short rates in anticipation of a recession and disinflation.
That's where we are today. The spread between 10-year Treasury notes and two-year notes, at 36 basis points, is the narrowest it has been since 2007.