A Federal Reserve Bank of San Francisco (FRBSF) macro economic letter discusses the Yield Curve and Recessions.

Here is the paragraph that caught my attention.

"Recently, Engstrom and Sharpe (2018) have argued that a spread of short-term Treasury rates—the difference between the six-quarters-ahead forward rate and the three-month yield (forward6q–3m)—might be preferable as a [recession] predictor because it focuses on expectations of the near-term path of monetary policy."

I do not know where the SF Fed came up with the six-quarters-ahead expectations data, but but it exactly matches a 2-year forward rate minus the current 3-month rate.

Spreads vs Recessions

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Predictive Power

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False Signals

The problem with the idea of using forward rates as a recession indicator is the false signals they provide.

I added the two main ideas in the SF Fed letter to the spreads vs recessions chart I created the other day.

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Spreads on August 27, 2018

  1. 10-Year Minus 3-Month: 0.73
  2. 10-Year Minus 2-Year: 0.19
  3. 10-Year Minus 5-Year: 0.10
  4. 10-Year Minus 7-year: 0.04
  5. 5-Year Minus 2-Year: 0.09
  6. 2-Year Forward Minus 3-Month: 0.75

The latest data for point 6 is June 29, updated July 10.

On the basis of points 1 and 6, a recession may be quite far off. Then again, there is no guarantee the yield curve inverts before a recession hits.

For further discussion of the San Francisco Fed macro letter, please see San Francisco Fed on the Predictive Power of Yield Curve Spreads.

Mike "Mish" Shedlock

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