An 80-Year Yield Curve History and its Implications

Includes: SPY, TLT
by: Richard Shaw

The chart below shows the spread between long-term Treasury Bond rates and Treasury Bill rates over an 80 year period. We thought that might put the current yield inversion in a larger context that could be useful.

The formula is long-term rates minus short-term rates. When the plot line is above zero, long-term rates are higher than short-term rates (the “normal” or upward slopping case). When the plot line is below zero, short-term rates are higher than long-term rates (the “inverted” case we have today)

The first thing we notice is that “normal” is an appropriate label for the upward slopping yield curve. That was the condition in 72 of the 80 years (90% of the time), measured as the average weekly condition for the year being upward slopping.

There were only 8 years (10% of the 80 years) when the average weekly yield curve status was inverted for the year: 1927, 1928, 1929, 1966, 1969, 1980, and 1981.

There were 17 years (21% of the 80 years) when there was at least one week of inverted yield curve: 1927, 1928, 1929 1930, 1959, 1966, 1967, 1968, 1969, 1970, 1973, 1974, 1979, 1980, 1981, 2000, and 2006 (but 9 of those 17 years had a positive average for the year).

Most of those inverted years were associated with tough times in the economy. It is generally held that a prolonged inverted yield curve produces a subsequent recession.

We also observe an average of the weekly yield spread (average of more than 4,000 weeks) to be a + 1.53%. That means that the long-term Treasury Bonds tended to yield about 1 ½ % over the T-Bills across the last 80 years. The range of the spreads is +4.5% to – 4.0% (but excluding the Nixon price control years the negative range was only about – 2%).

Possible implications for rates going forward:

• If long-term rates remain stuck in the 4.5% range, then we might expect T-Bill rates to fall to the 3% range to restore the historic +1.5% spread

• If T-Bill rates remain at the current roughly 5% range, then we might expect long-term Treasury Bonds rates to rise to about 6.5% to restore the historic +1.5% spread.

An intermediate scenario is also possible and perhaps more likely.

According to history, generally accepted economic theory, and Bill Gross’s current predictions, if something doesn’t give soon, we are in for a difficult time for the economy, stocks and housing.

If short-term rates fall, everyone will party, stocks will rise and housing may stop falling or go up.

If long-term rates rise, and short rates stay the same, probably things won’t be so nice for a while in the stock market and housing market, and long bonds will fall.

The SPDRs (NYSEARCA:SPY) and the iShares Lehman 20+ Year Treas Bond (NASDAQ:TLT) would be good major proxies to measure the financial outcomes, whatever they will be.

History tells us that something has to give. Recession follows inverted yield curves (which cures the inversion) and inverted yield curves don’t last and are relatively rare.