Magazine article Economic Trends

The Yield Curve's Predictive Power

Magazine article Economic Trends

The Yield Curve's Predictive Power

Article excerpt

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12.21.06

The slope of the yield curve has achieved some notoriety as a simple forecaster of economic growth. The rule of thumb is that an inverted yield curve (short rates above long rates) indicates a recession in about a year, and 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.

Lately, the yield curve has some forecasters worried. One reason for concern is that the spread is currently negative: with 10-year rate at 4. …

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