Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, May 2013

Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, May 2013

Article excerpt

Covering April 16, 2012-May 20, 2013

Overview of the Latest Yield Curve Figures

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.

More generally, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth. One measure of slope, the spread between ten-year Treasury bonds and three-month Treasury 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 slope change had a bit more impact on the probability of a 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 May is 6.1 percent, down from April's 8.1 percent, though up a bit from March's 5.9 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.

More generally, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth. One measure of slope, the spread between ten-year Treasury bonds and three-month Treasury 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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