Wednesday, December 30, 2009

Yield Curve Provides Ominous Signs

The yield curve has been the subject of an increasing amount of chatter in recent weeks, as long-term interest rates rise and short-term rates remain low.  Some stories have suggested that the curve is at record highs, but based on the official definition from the NY Fed, while the yield curve spread is extremely high, it is not quite at a record.
According to literature from the NY Fed's website, the yield curve is defined as, "the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill."  On a historical basis it has been "a valuable forecasting tool...in predicting recessions two to six quarters ahead."
Using the Fed's definition of the yield curve, the chart below shows the historical spread between the yields on the 3-month and 10-year US Treasury (in basis points).  As shown in the chart below, the current level of the yield curve is nearly two standard deviations above its historical average.  The only other time that the spread got this wide was back in August 1982.
Yield Curve123009