There has been a lot of chatter in the markets lately about the U.S. “yield curve." This is the difference in yield (essentially, the return on investment in Treasury bonds) between U.S. 2-year and 10-year Treasury notes.

What's so interesting is that the short-term, 2-year yields are at the highest levels seen since mid-2008. In fact, those yields exceeded 1.8 percent this week.

Meanwhile, 10-year Treasury yields have remained stubbornly low, having ranged between 2.1 and 2.5 percent since March. The last time the 10-year spent any meaningful time above 3 percent was mid-2011.

Why is this a concern? When a yield curve inverts (if the 2-year yield were to trade higher than the 10-year yield), that is considered to be a predictor of an economic recession.

But is there real reason for concern given the strong GDP numbers we've seen over the last two quarters?

We asked some colleagues as well as some external analysts for their opinions.

The reason for the high yields on the short end of the curve is easy. The yield tracks the monetary policy of the U.S. Federal Reserve. As the Fed has signaled a solid but gradual tightening path this year and next, the correlation with high rates on 2-year Treasuries holds.

But what about the longer-duration yields? The answers there are not as obvious. Clearly one factor is the market realization that inflation looks to remain low. If investors expected higher inflation in the long term they would demand higher yields. But the low yields make it seem as though investors expect inflation to stay low forever.

WorldBondYields

Another significant factor can be illustrated by the above chart, which compares world bond yields. International investors look for yield in U.S. government bonds because, relatively speaking, U.S. 10-year rates – even as low as they are – are more attractive than the rates offered by most other developed economies.

With the rest of the world still awash in liquidity from central banks, investors are looking for alternatives – particularly when some government bond yields are near zero or even negative, such as in Switzerland.

Our View: Is the flattening of the yield curve cause for worry? No one we spoke with thought so, because so many other economic indicators point to a strong economy going forward. It may be that this metric is an outlier for reasons that are unique to this particular time in history.

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