The Yield Curve as a Leading Indicator
Research beginning in the late 1980s documents the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity. Today, a substantial body of evidence exists from which various useful stylized facts have emerged.
For example, the difference between 10-year and 3-month Treasury rates, which is normally positive, has turned negative before each of the last seven officially-dated U.S. recessions (see graph below). Remarkably, a flat or inverted yield curve has preceded every recession in the United States since the 1950s, with only one debatable false signal. Most recently, the curve was inverted from August 2006 to May 2007, and on December 1, 2008 the NBER announced the official start of a recession in December 2007.
The links on the left provide more detailed information:
- Answers to frequently-asked questions about the yield curve and its predictive power for future real economic activity, including recessions. Contains an extensive list of references to articles and other materials about the yield curve as a leading indicator.
- Current and historical estimates of the probability of a recession twelve months ahead.
- References to selected readings about the yield curve as a leading indicator.
The links include updates of material originally available at the New York Fed web site.
"… signals from the yield curve have often been dismissed because of supposed changes in the economy or special factors influencing interest rates. This paper, however, shows that the puzzling power of the yield curve to predict recessions relative to that of professional forecasters appears to have endured, despite the wide dissemination of knowledge about the yield curve's predictive power."
From
Glenn Rudebusch and John Williams, Federal Reserve Bank of San
Francisco,
in "Forecasting
Recessions: The Puzzle of the Enduring
Power of the Yield
Curve"