Yield Curve - One Positive Signal Amid A Growing Recessionary Storm

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Includes: DFVL, DFVS, DTYL, DTYS, GSY, IEF, IEI, ITE, PST, RINF, SCHR, TBX, TBZ, TYD, TYNS, TYO, UST, VGIT
by: ValueWalk

By Eric Bush, CFA

2016 Ahead There are several recessionary warning flags in the US (and global) economy popping up right now. Industrial production has steadily fallen and is 2% of its high, corporate profits look set to decline once again in the fourth quarter and the price of oil has plummeted. However, one important recessionary signal is still far from flashing red: the US yield curve.

Going back to 1954, we have had nine circumstances when the spread between 10-year treasury yields and 3-month treasury yields goes negative (i.e. yield curve inverts). Only once, in 1967, did the US not fall into a recession within the next 12 months. Fortunately today, the 10-year - 3-month spread sits at a very healthy 175 basis points.

As the chart below shows, the yield curve tends to flatten right before a recession occurs and then it actually steepens during the recession. For example, the 30-year to 3-month spread went from 313 basis points in 1972 to -186 basis points in 1973 and then the economy fell into a recession from 12/1973 to 4/1975. In 5/2004, the 30-year to 3-month spread was at 382 basis points. By 3/2007, it had fallen to -66 basis points and then the US fell into a recession officially starting in 1/2008.

Granted, we have seen the 30-year to 3-month spread flatten over the past several years as the current level of 175 basis is 122 basis points from the 2013 high and 208 basis points off the 2011 high. However, as long as this spread remains well above the zero line, a US recession will hopefully not be on the immediate horizon.

Click to enlarge