by Matt Egan, March 28, 2018: 2:06 PM ET
CNN Money

A warning light is flashing in the bond market.

An obscure measure known as the yield curve is flattening. That means the gap between short and long-term Treasury rates has narrowed.

The flattening yield curve signals concern that the Federal Reserve could be hitting the brakes on the economy so hard that it inadvertently puts the United States into another recession.

Stocks tumbled on Tuesday after the yield curve narrowed to nearly the smallest point since before the Great Recession.

"People are worried the Fed will keep tightening us into an accident. Historically, that's what usually happens," said Peter Boockvar, chief investment officer at The Bleakley Advisory Group.

Even if that's not the case this time, the flatter yield curve is bad news for banks, which pay interest on short-term rates and lend at long-term rates. Bank stocks like Citigroup (C) and PNC (PNC) fell sharply on Tuesday.

The action in the world's largest bond market also raises the specter of the yield curve eventually inverting, meaning short-term rates would be higher than long-term ones. Such a phenomenon is rare -- and spells bad news. It's widely believed to signal a looming recession. It happened prior to the Great Recession as well as the 2001 downturn.

"History shows that inverted yield curves have tended to trigger financial crises, which have caused credit crunches and recessions," Ed Yardeni, president of investment advisory Yardeni Research, wrote in a recent report.

The yield curve is nowhere near inverting right now, and few economists expect a recession on the horizon. Growth is expected to be strong this year, thanks in part to Washington stimulating the already-healthy economy with tax cuts and extra spending.

Just last month Wall Street was concerned the economy could overheat, creating a burst of inflation the Fed would have to cool off by raising rates aggressively. The 10-year Treasury yield spiked above 2.9%, sending the stock market into turmoil. Investors feared a move above 3% would spark more turmoil.

Now, the shrinking 10-year yield is spooking Wall Street.

"It shows that markets can be fickle," said David Kotok, chairman and chief investment officer of Cumberland Advisors.

The 10-year yield has descended sharply to around 2.75% because of a range of factors, including a flight to safety during the recent stock market turbulence and easing concerns about the threat of inflation. It also reflects expectations for softer economic growth at the start of 2018. Barclays trimmed its first-quarter GDP forecast to 1.8% on Wednesday.

At the same time, two-year Treasury yields have climbed to their highest levels since 2008 because the Fed has suggested it will continue hiking rates. Short-term rates are more closely linked to Fed actions.

Those diverging forces have narrowed the yield curve. That's caught Wall Street's attention.

"I don't think it's suggesting an imminent recession, but it is signaling the Fed may be too aggressive," said Greg Peters, senior investment officer at PGIM Fixed Income.

Morgan Stanley analysts called the flattening curve a "potential warning" and key gauge of concerns about the Fed "getting ahead of itself."

Jerome Powell, the new Fed chief, was even asked about an inverted yield curve during his debut press conference last week. Powell suggested it might not signal a recession this time. He noted that in the past "inflation was allowed to get out of control, and the Fed had to tighten, and that put the economy into a recession." Powell added, "that's not really the situation we're in now."

Powell's comments didn't shift attention from the bond market though.

"It's worrisome that Powell pooh-poohed the fact we're close to an inversion," said Jay Hatfield, CEO of hedge fund Infrastructure Capital Advisors, which manages a series of ETFs and hedge funds.

Hatfield called it "probably the most reliable economic indicator in the history of economics."

Kotok is watching the yield curve "like a hawk," but he's not worried about a downturn yet. He argued that the double whammy of tax cuts and government spending will be powerful enough to offset the Fed tapping the brakes on growth.

"I'm not ready to take this as a recession message," he said.

By Evie Liu July 24, 2018 5:35 p.m. ET - Barron's

The stock market in the ninth year of its recovery from the Financial Crisis, and some investors are seeing ominous signs in something known as the yield curve.

The yield curve is simply the difference between the yields on the 10-year and two-year Treasuries, and it has a long history as a recession indicator with a near-perfect record in the past. When the yield on the two-year Treasury rises above the yield on the 10-year it's called a yield curve inversion, and one has preceded almost all economic downturns since the 1950s.

With the curve flattening of late—it had dropped from  0.95 percentage point one year ago to 0.25 percentage point earlier this month, before bouncing to 0.32 today—some observers worry that a yield curve inversion might be just over the horizon, something they argue would signal a looming recession and the start of a bear market.

Or maybe not. Here are six reasons not to fear the flattening yield curve:

1. The yield curve may not be signaling a weakening U.S. economy. While the short-end of the curve is mainly driven by Fed policy that reflects domestic economic strength, the long-term yields are increasingly influenced by the global bond market, explains Jonathan Golub, U.S. equity strategist at Credit Suisse. The near-zero yields on 10-year German bunds and Japanese JGBs, for example, make the U.S. 10-year Treasury look much more attractive on the international market and therefore lead to the rising price and lowering yields on the long end of the curve.

At the same time, the U.S. Treasury is issuing fewer long-term notes and bonds than it used to in favor of short-term bills, writes Vincent Deluard at INTL FCStone Financial. Higher issuance means more supply, lower price, and higher yields for the short-term Treasuries. The narrowing yield spread might just be a result of the supply imbalance in the bond market rather than expectations about the economy, Deluard says.

2. There are no other signs of a looming recession. Historically, an inverted yield curve has always been accompanied by a group of other ominous signals before the economic downturn. But we are not seeing those yet this time. The year-over-year growth of the Leading Economic Index (LEI), which includes 10 major economic indicators such as unemployment claims, consumer confidence, manufacturers’ new orders, and stock price, has turned negative before every recession since the 1970s. The index is up by 5.8% compared to 12 months ago and certainly isn't sounding a recession alarm.

3. The Fed can keep the curve from inverting if it wants to. Traditionally, the long-end of the curve—the 10-year Treasury and out—is thought to indicate bond investors' long-term vision of the market, free from manipulation by central banks. That might not be the case any longer, writes INTL FCStone's Deluard. He argues that the slope of yield curve nowadays can be easily controlled by central banks' policy such as the Operation Twist and isn't the organic market indicator it once was. "The yield curve is no longer the careful judgment of wise long-term investors, but the Frankenstein-like creation of central bankers," Deluard explains.

4. The curve can remain flat for years. During the greatest bull market of the 1990s, the yield curve remained close to flat for four years from 1995 to 1999, according to Tan Kai Xian, analyst at Gavekal Research. "It was only when it significantly inverted in 2000 that it prefigured a bear market and recession," writes Kai Xian.

5. Even when it does invert, the curve doesn't tell us when a recession will start. Although an inversion has preceded each recession over the past 50 years, the lead time has been inconsistent. Recession can come anywhere from 14 to 34 months after the curve flips upside down, according to Golub at Credit Suisse.

6. In fact, an inversion is often a buying opportunity. During each of the past seven economic cycles, the S&P 500 has gained in the six-months before a yield-curve inversion, according to Tony Dwyer, analyst at Canaccord Genuity. And even an inversion itself wasn’t an immediate sell signal. The S&P 500 rose for an average of 18.5 months and saw a median gain of 21% from the day of the inversion to the market’s peak.