The gap between short and long-term Treasury yields is at its narrowest in more than a decade, reflecting investors’ confidence that the Federal Reserve will maintain its current pace of interest-rate increases despite ongoing skepticism about the longer-term outlook for economic growth and inflation. The yield curve, the difference in interest rates between short-term and long-term U.S. treasuries, has flattened considerably this year as the Federal Reserve has raised the Fed Funds rate and long-term rates, which are set by the market, have stayed the same.
Typically, a flat or inverted yield curve can be a sign that a recession is on the horizon, that marks a stark contrast to investor expectations that the newly passed tax cuts could accelerate economic growth and market returns. The yield curve forecasts rates in the future, and right now the curve is forecasting trouble ahead. As short-term rates rise during a healthy economy, long-term rates usually follow suit. Currently, long-term U.S. treasuries aren’t responding to the increased economic activity and are instead focused on a future that doesn’t look as rosy as the current conditions.
Some investors are concerned the flattening curve suggests the Fed could raise short-term interest rates faster than the market expects and ultimately cause a slowdown in economic growth.