Investors Should Fear a Steeper Bond Yield Curve

Many analysts point out that a flat or inverted yield curve may presage a recession, so last year's major shrinkage between short- and long-term U.S. Treasury rates is a disturbing sign. The curve has recently steepened a bit, however, suggesting investors now fear that Federal Reserve policy could allow inflation to become embedded in the economy. That would also be a concern. Can both be threats to the markets? Yes, but not at the same time.

Some Fed officials suggested last year's flatter yield curve was enough to deter them from supporting additional interest-rate increases. This concern was illogical and excessive. The Treasury curve can flatten and even invert without necessarily leading to recession. But then, the steepening of the yield curve over the past month is not necessarily a good sign, either.