Magazine article Economic Trends

What Is the Yield Curve Telling Us?

Magazine article Economic Trends

What Is the Yield Curve Telling Us?

Article excerpt

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Since last month, longer-term interest rates have increased with little movement in short rates, increasing the slope of the yield curve. One reason for noting this is that 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.

The yield curve had been giving a rather pessimistic view of economic growth for a while now, but with the increasingly steep curve, this is turning around. The spread remains robustly positive, with the 10-year rate at 4.67 percent and the 3-month rate at 4.00 percent (both for the week ending October 12). Standing at 67 basis points, the spread is up from September's 38 basis points and well above August's -4 basis points. 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 is broadly in the range of other forecasts, if a bit on the low side.

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While such an approach predicts when growth is above or below average, it does not do so well in predicting the actual number, especially in the case of recessions. …

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