The US yield curve is flattening. Should markets be worried?

The difference in yield between US 10-year and two-year sovereign bonds this week contracted to less than 130 basis points, its narrowest since February and only a dozen basis points shy of the tightest spread since the height of the financial crisis in early 2008.

Much of the contraction of late is due to surging short-term yields as the Federal Reserve prepares to raise interest rates, and long-term yields remain suppressed.

In the past, this kind of flattening would get investors worried because it suggested tighter monetary policy was going to damage economic growth.

Bank stocks would struggle as the prospect of less borrowing and tighter lending margins hit sentiment.

But this time, the S&P 500 Bank index sits just shy of a seven-year high. The broader S&P 500 is eyeing record levels.

The reason for this calm is that the pressures on the long end currently are considered benign.

Inflation is low as energy prices languish. Wage growth is muted.

The Federal Reserve is expected to stress that the pace of monetary tightening will be very slow.

Meanwhile, benchmark US yields are kept low because Treasuries remain attractive relative to their peers.

The US 10-year note is offering around 175 basis points more than equivalent maturity Bunds, close to the widest spread in 25 years.

The spread with Japan is about 190 basis points.

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