Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, Febuary 2014

Magazine article Economic Trends

Yield Curve and Predicted GDP Growth, Febuary 2014

Article excerpt

Covering January 17, 2014--February 14, 2014 by Joseph G. Haubrich and Sara Millington

Overview of the Latest Yield Curve Figures

The yield curve flattened slightly over the past month, with the three-month (constant maturity) Treasury bill rate at 0.04 percent (for the week ending February 14), even with January's reading and down from December's 0.07 percent. The ten-year rate (also constant maturity) dropped to 2.75 percent, down from the January level of 2.86 percent, which was also the rate for December. The slope decreased to 271 basis points, down from January's 282 basis points and still below December's 279 basis points.

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The steeper slope had a negligible impact on projected future growth. Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.3 percentage rate over the next year, even with January's rate and just barely above the 1.2 percent seen in December. The influence of the past recession continues to push towards relatively low growth rates. Although the time horizons do not match exactly, the forecast is slightly more pessimistic than some other predictions, but like them, it does show moderate growth for the year.

The slope change had only a slight 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 February at 1.74 percent, up a bit from January's estimate of 1.48 percent and December's 1.50 percent. So although our approach is somewhat pessimistic with regard to 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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