Spreads Watch

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Includes: CVOL, EGF, FIBR, FTT, GOVT, IVOP, PLW, SVXY, TAPR, TVIX, TVIZ, USTB, UVXY, VIIX, VIIZ, VIXM, VIXY, VMAX, VMIN, VXX, VXZ, XIV, XVZ, XXV, ZIV
by: Econbrowser

Editor's note: This article was originally published on June 3, 2018, by Menzie Chinn here.

In all the excitement between the Italian crisis and the US lashing out with tariffs to be levied against our allies, it was easy to overlook this event:


Figure 1: Ten-year constant maturity Treasury minus three-month Treasury bill yield spread on secondary market (blue), and ten-year minus two-year yield spread (green), both daily, %. Last observation is 6/1. Source: Federal Reserve via FRED, Bloomberg, and author's calculations.

The 10-year-3month spread broke through 1%, to 0.9%, while the 10-year-2-year spread plumbed new depths, to 0.4%. As the graph indicates, the last time around in 2005, this event presaged the onset of a recession about two and a half years later. As I noted in an earlier post, about three of the six times that this has happened in US post-war history, a recession has not occurred.

Was this a special event, driven by one-off factors? The spread dropped on 5/29 as the ten-year dropped, likely because of safe-haven effects. This point is highlighted by Figure 2, which shows the VIX against the spread.


Figure 2: Ten-year constant maturity Treasury minus three-month Treasury bill yield spread on secondary market (blue, left scale), VIX (red, right scale). Source: Federal Reserve via FRED, Bloomberg, and author's calculations.

Note, however, that by 6/1 the VIX had returned to more normal levels, and yet the spread remained at 1%. In other words, the spreads continue their downward march.

Using data through March and a formal model, the probability of a recession within of 12 months of March was 30%. Presumably for the 12 months from May, the probability is higher.