Magazine article Economic Trends

The Yield Curve's Prognosis for Economic Growth

Magazine article Economic Trends

The Yield Curve's Prognosis for Economic Growth

Article excerpt

05.16.07

In its limited capacity as a simple forecaster of economic growth, the slope of the yield curve has been giving us a rather pessimistic view for a while now. Though rates have fallen since last month, the spread remains negative: with 10-year Treasury bond rate at 4.65 percent and the 3-month Treasury bill rate at 4.88 percent (both for the week ending May 11), the spread stands at a negative 23 basis points, not quite as negative as a month ago. Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 2.4 percent rate over the next year. This prediction is on the low side of other forecasts.

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The rule of thumb for using the slope of the yield curve to forecast economic growth is that an inverted yield curve (short rates above long rates) indicates a recession in about a year. Yield curve inversions have preceded each of the last six recessions (as defined by the NBER, very flat yield curves preceded the previous two, and there have been two notable false positives: an inversion in late 1966 and a very flat curve in late 1998. More generally, though, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth. One measure of slope, the spread between 10-year bonds and 3-month T-bills, bears out this relation, particularly when real GDP growth is lagged a year to line up growth with the spread that predicts it.

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The expected chance of a recession in the next year based on statistical modeling of the yield curve and GDP is 35 percent, down a bit from last month's value of 38 percent and March's 46 percent. …

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