Some macro analysts suspect that the Fed might back off its tightening program if the yield curve continues to flatten. Philly Fed President Harker hinted at such an outcome in comments last Friday.
The yield curve is not yet flat enough to suggest a heightened recession risk, and would seem to have room to accommodate further Fed tightening.
It is possible that equity types are expressing concern about the yield curve are actually worried about the possible implications of the economy having achieved full employment, either in fact or as perceived by the Fed. If so, I would say those concerns are valid.
In principle, the Fed might back off if the yield curve flattens more than I assume it will in response to the next couple rate hikes. This is just another way of saying strength in 10s, presumably reflecting surprise economic weakness, could be communicated into fed funds futures.
But the Fed cannot “back off” the need for slower growth that seems to be implied by the achievement or near achievement of full employment. And I would guess this is what is really bugging the equity market. One way or the other, demand growth probably needs to be tamed – down toward the economy’s apparently mediocre potential.