The Yield Curve Spread is definitively THE BEST predictor of future economic activity and recessions in the United States. A negative yield curve spread has preceded EVERY recession that we have data for, with recessions occurring 9-24 months after the yield curve inverts. Only once was there a yield curve inversion that resulted in a drop in production, but not an officially declared recession, in 1966.

Yield Curve Spread:
10-year Treasury rate minus 1-year Treasury rate 

The graph above is created by subtracting the 2-year Treasury interest rate from the 10-year Treasury interest rate (both rates shown below). The difference between this long-term rate and shorter-term rate, are referred to as the "Yield Curve Spread."

 

You can see (below) that during and just after a recession, the Fed lowers short-term rates, which increases the yield curve spread (above). The spread then shrinks as the Fed raises short-term rates as the economy improves. Once the yield curve inverts, a recession follows within the next 2 years.

10-year Treasury rate (blue) & 1-year Treasury rate (red)

Let's now look more closely at the last few economic cycles, and what's taking place today. We can see (above) the longer-term decline in 10-yr Treasury rates, with rates especially dropping during a recession. The Fed drags the 1-yr rate down significantly more, increasing the spread between the two rates. The Fed has kept the yield curve spread higher for longer than it has in the past, by delaying the rise in short-term rates for much longer than prior economic cycles, and increasing short-term rates to a lesser degree than prior cycles. Yet the result is similar. The Fed has increased rates until there is very little spread between short-term and long-term rates, and the yield curve spread has shrunk to close to zero as of May 2019.

10-year Treasury rate (blue) & 1-year Treasury rate (red)

Let's now look more closely at the last few economic cycles, and what's taking place today. We can see (below) the longer-term decline in 10-yr Treasury rates, with rates especially dropping during a recession. The Fed drags the 1-yr rate down significantly more, increasing the spread between the two rates. The Fed has kept the yield curve spread higher for longer than it has in the past, by delaying the rise in short-term rates for much longer than prior economic cycles, and increasing short-term rates to a lesser degree than prior cycles. Yet the result is the same. The Fed has increased rates until there is little, no, or negative spread between short-term and long-term rates.

Yield Curve Spread:
10-year Treasury rate minus 3-month Treasury rate 

Since late 2018, the yield curve spread has continued to decline, crossing negative to an inverted yield curve for a week in March 2019, then negative again for a short period in May 2019. Continued inversions of the yield curve are the strongest signal for a recession in the succeeding 12-24 months. 

Yield Curve Spread:
10-year Treasury rate minus 3-month Treasury rate 

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