Summary: On its own, a flattening yield curve is not an imminent threat to US equities. Under similar circumstances over the past 40 years, the S&P has continued to rise and a recession has been a year or more in the future. Investors should expect the yield curve to flatten further in the months ahead.
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Investors are concerned about the flattening yield curve. Enlarge any image by clicking on it.
The yield curve measures the gap between long and short term treasuries. The curve "flattens" when either short term rates rise faster than long term rates, or when long term rates fall faster than short term rates. The standard interpretation is that a flattening curve means that the bond market is pessimistic about future growth (low long rates) while the the Federal Reserve is overly worried about inflation (rising short rates). The bond market's view is typically more relevant.
Our monthly macro updates (here) start with the latest yield curve, with the note that the yield curve has 'inverted' a year ahead of every recession in the past 40 years (arrows). With the yield curve still 60 basis points away from inversion, the current expansion will probably last well into 2018, at a minimum. In short, the risk of an imminent recession is low.
As an example, a flattening yield curve (blue line) has been associated with better employment (black line). Again, the main economic risk has been after the yield curve has inverted; note how unemployment has subsequently started to rise (from Topdown Charts).