The Yield Curve And Its Importance As An Economic Indicator

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Includes: FLAT, STPP
by: Ted Kavadas

Summary

The yield curve is seen by many as a top economic indicator.

However, changes in the economic environment have impacted its "purity".

Two long-term charts are presented comparing it against recession and the S&P 500.

Many people believe that the yield curve is an important economic indicator. On March 1, 2010, I wrote a post on the issue, titled "The Yield Curve As A Leading Economic Indicator."

An excerpt from that post:

On the NY Fed link above, they have posted numerous studies that support the theory that the yield curve is a leading indicator. My objections with using it as a leading indicator, especially now, are various. These objections include: I don't think such a narrow measure is one that can be relied upon; both the yields at the short and long-end of the curve have been overtly and officially manipulated, thus distorting the curve; and, although the yield curve may have been an accurate leading indicator in the past, this period of economic weakness is inherently dissimilar in nature from past recessions and depressions in a multitude of ways - thus, historical yardsticks and metrics probably won't (and have not) proven appropriate.

While I continue to have the above reservations regarding the "yield curve" as an indicator, I do believe that it should be monitored.

As an indication of the yield curve, below is a weekly chart. The top plot shows the spread between the 10-year Treasury and two-year Treasury, from January 1, 1990, through February 10, 2016. The February 10, 2016, value is 1.00% (1.705% - .71%). The bottom plot shows the S&P 500:

Chart courtesy of StockCharts.com

Chart creation and annotation by the author

10 year 2 year spread

Additionally, below is a chart showing the same spread between the 10-year Treasury and 2-year Treasury, albeit with a slightly different measurement, using constant maturity securities. This daily chart is from June 1, 1976, to February 9, 2016, with recessionary periods shown in gray. This chart shows a value of 1.05%.

10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity

Source: Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus Two-Year Treasury Constant Maturity (T10Y2Y), retrieved from FRED, Federal Reserve Bank of St. Louis; accessed February 11, 2016

The Special Note summarizes my overall thoughts about our economic situation

SPX at 1,851.86 as this post is written

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.