The yield curve flattens when the short-term rates get closer to the long-term rates and can actually get inverted if short-term rates go higher than the long-term rates.
For instance if the two year Treasury bond is paying 3% and the ten year bond is paying 2% you have an inverted yield curve.
The Fed controls the short-term rates much more than it does long-term rates so this happens when traders buy the long-term bonds in anticipation of the Fed eventually lowering rates.
A flattening yield curve happens when you are an interest rate hiking cycle and traders believe it is going to come to an end.
That is where we are as you can see from this chart that shows the yield spread between the two year Treasury bond and the ten year.
So the spread between the two year and ten year Treasuries is now less than 0.40.
So if nothing changes that means two more rate hikes would move bonds closer to an inverted yield curve.
We are late in the interest rate hiking cycle and that means that we are also late in this stock market bull cycle and economic expansion.
That’s probably why Ben Bernanke has been predicting a recession by 2020 and the stock market has been drifting sideways with very narrow internal leadership since January in what appears to be a slow motion stage three top.
If we step back though it is the entire global stock market system that is in a stage three top and not just the US.
During times of transition when you come out of them new leadership often emerges in new asset classes.
I talked about this situation and how the Federal Reserve is likely to react to it before the year is over in an interview I did two weeks ago with Scott Horton titled: Jerome Powell’s Economy, Boom Bust, and Investing.
You can also download the interview as an MP3 file by clicking here.