What the 2-10 Treasury Yield Spread Indicator Is Telling Us

Includes: FIVZ, IEF
by: Doug Short

Bloomberg has an article today with the provocative title "Bond Yields Showing No Economic Spoils for Republicans." Political posturing aside, the observation that caught my attention was this:

The economy has never contracted with the difference between short- and long-term Treasury yields as wide as it is now. That gap, at 2.11 percentage points for 2- and 10-year notes, signals a 15.5 percent chance of a recession in the next year, according to the Federal Reserve Bank of Cleveland.

Let's look at a chart of the 2-10 yield spread since June 1976 (the earliest Federal Reserve data) with an overlay of recessions and the Federal Funds Rate. Note: I'm using the Federal Reserve Bank of St. Louis estimated 2009 mid-year end date for the 2007 recession.

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(Click to enlarge)

All five recessions since the beginning of our 2-10 spread indicator have been preceded by a spread inversion. Does the current spread, 2.13 percent as of Friday's close, preclude the chance of a double dip? Perhaps.

On the other hand, perhaps the current Zero Interest Rate Policy (ZIRP) with a target Fed Funds Rate of 0% - 0.25% puts us in "uncharted" territory, where recessions can happen without an inverted curve.

And of course there are some who would argue that the recession that began in 2007 hasn't really ended. Indeed, the National Bureau of Economic Research, the official arbiter of recessions, hasn't declared the end date.

Disclosure: No positions