Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, February 2012

Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, February 2012

Article excerpt

Overview of the Latest Yield Curve Figures

Over the past month, the yield curve has flattened somewhat, as short rates moved up while longer rates barely budged. The three-month Treasury bill rose to 0.11 percent (for the week ending February 17), up from January's 0.04 percent and December's 0.01 percent. The ten-year rate stayed below two percent, but not by much, coming in at 1.97 percent, just up from January's 1.96 percent and December's 1.94 percent. The twist dropped the slope a bit, to 186 basis points, down six points from January s 192 bp and also below December s 193bp.

The lower slope was not enough to have an appreciable change in projected future growth, however. Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 0.7 percent rate over the next year, equal to the past two months. The strong influence of the recent recession is leading towards relatively low growth rates. Although the time horizons do not match exactly, the forecast comes in on the more pessimistic side of other predictions but like them, it does show moderate growth for the year.

Likewise, there was little change in the probability of recession. Using the yield curve to predict whether or not the economy will be in recession in the future, we estimate that the expected chance of the economy being in a recession next February at 6.9 percent, a bit above January s at 6.4 percent, and Decembers at 6.5 percent. So although our approach is somewhat pessimistic as regards the level of growth over the next year, it is quite optimistic about the recovery continuing.

The Yield Curve as a Predictor of Economic Growth

The slope of the yield curve--the difference between the yields on short-and long-term maturity bonds--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 seven recessions (as defined by the NBER). One of the recessions predicted by the yield curve was the most recent one. The yield curve inverted in August 2006, a bit more than a year before the current recession started in December 2007. There have been two notable false positives: an inversion in late 1966 and a very flat curve in late 1998.

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More generally, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth. …

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