That Tweet by Holger Zschaepitz got me thinking more about the flattening US treasury yield curve. Most analysts follow the 10-year to 2-year spread. The Tweet mentioned 10-year to 7-year and 1-year to 3-year spreads. Here are some charts I created in Fred.
10-Year Minus 7-Year Spread
This portion of the yield curve looks highly likely to invert soon. That said, predicting recessions off such divergences is clearly problematic.
3-Year Minus 1-Year Spread
This is another unusual spread to watch. It's currently at 34 basis points. Assuming the 1-year yield rises 25 basis points on a Fed hike (probable), but the 3-year yield doesn't (questionable), the Fed could get in no more than one more hike before this portion of the yield curve inverts.
10-Year Minus 2-Year Spread
This chart is so popular that Fred has it precalculated. I created the first two charts and the following chart using Fred tools.
The last three recessions all started with 10-2 spreads higher than 35 basis points. Thus we are already well into recession territory. The one missing ingredient is a prior 10-2 inversion.
10-Year Minus 1-Year Spread
As long as we are investigating unusual ranges I thought I would post one of my own. The "Great Recession" started with a spread 14 point higher. The Dot-Com recession started with this spread 11 points lower, and the July 1990 recession started with the spread 17 points lower.
This spread went negative at some point before each of the last five recession. Unlike the 10-2, 3-1, and 10-7 this indicator gave no false positives an it also gave plenty of warning.
Missing Warning Signal
Will we have a recession without the yield curve inverting?
I don't know, nor does anyone else.
Fundamentally, there is no reason to believe an inversion is a necessary ingredient for a recession. Japan offers proof enough unless we are to assume Japan is different.
One strong reason to suspect we may be similar to Japan is the length of time the Fed held rates close to zero. That certainly was different. Tests of zero-bound constraints are different as well.
Everyone is guessing. But interestingly, nearly everyone seems to be guessing the same way: There will be a warning signal.
What if there isn't?
We may find out soon enough. If the Fed gets in two more hikes, I suspect that some portions of the curve will invert.
But even so, I also suspect the vast majority of investors will ignore that signal too.
In fact, I know they will. Mathematically they must. For everyone trying to time the top, there will be a dip buyer buying the dip. Mathematically, there cannot be a stock market escape in aggregate.
Mike "Mish" Shedlock