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The difference between US short and long-term bond yields has dropped below the 1 per cent mark for the first time in a decade, sparking concerns that the post-crisis economic expansion may be approaching its end.

The so-called yield curve made up by the US government’s borrowing costs is one of the most widely followed financial indicators, since its shape tends to augur economic downturns. The yield curve has flattened and ultimately inverted ahead of nearly every recession in the US after the second world war.

On Tuesday the difference between two and 30-year US Treasury yields slipped to 98.8 basis points, below the 100 bps (or 1 per cent) level for the first time since November 2007.

The yield curve tends to flatten as the Federal Reserve raises short-term interest rates, even as investors’ views of the future economic outlook dims. That spurs them to buy longer-maturity Treasury bonds, pushing those yields down.

The 2-10 year Treasury spread, another important measure of the yield curve, has also fallen to a decade low, slipping to 58 bps on Tuesday, more than half its level at the start of the year. Some analysts now reckon that the yield curve will invert – when long-term bond yields are lower than short-term ones – sometime in 2018.

In a blog post on Tuesday, Michael Bauer of the Federal Reserve Bank of San Francisco noted that the flattening yield curve was reminiscent of the “conundrum” that baffled former Fed chair Alan Greenspan in the noughties, which preceded the financial crisis.

However, Mr Bauer argued that there was “compelling” evidence that the recent flattening was due to the receding inflation risk, global uncertainty and a sharp shift downwards in what investors considered the “neutral” long-term interest rate that keeps the economy ticking along. Indeed, the yield curve was flat or negative for several years before the financial crisis rattled the global economy.

However, some analysts and investors are perturbed, and in a note to clients, Lombard Street Research said this new conundrum could have important implications for the outlook for markets in the coming year.

With the yield curve continuing to flatten, some investors are talking about the curve inverting in 2018, traditionally a leading recession signal. Others disagree, arguing that markets are on the brink of a dangerous 1994-style selloff. The resolution of this debate will have a powerful influence on a wide range of global asset prices.

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