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JACKSON FINANCIAL ADVISORS

Members of D.A. Davidson & Co.

Better Measures of the Yield Curve

“The shape of the Treasury yield curve continues to be a subject of great interest to the market, due to the now-widespread belief that a flat or negatively-sloped yield curve is a sure-fire harbinger of recession. I've disagreed with this of late, because while a negatively-sloped yield curve has in fact preceded almost all of the recessions in the past 50 years (with the notable exception of the economic collapse brought on by Covid shutdowns), there are other indicators (e.g., real yields, swap spreads, credit spreads) which also must be observed if one is to reliably anticipate recessions. 

 

So the shape of the yield curve can help, but it's not bullet-proof. And to complicate things further, there are a variety of ways to measure the shape of the yield curve, and they often give conflicting signals. 

 

...This begs the question: which measure of the slope of the yield curve is the most reliable guide to recessions? 

 

The spread I have generally preferred is the 1-10, but there's one I think is even better: the spread between the real Fed funds rate and the real yield on 5-yr TIPS. Here I'm referring the real yield curve, not the commonly-used nominal curve. Real yields, after all, are far more important than nominal yields because they reflect the true cost of borrowing and the true returns to saving, and those are what create the most powerful incentives in the economy. The Fed is right when it says that it is not actually targeting the nominal Fed funds rate, but instead the real Fed funds rate; that is the best measure of the stance of monetary policy, and that is what a good yield curve analysis should focus on as its starting point (i.e., the overnight Fed funds rate after adjustment for inflation). 

 

... Today, neither suggests an impending recession—not even close.”

 

(Better measures of the yield curve dated April 8, 2022 by Scott Grannis, Chief Economist with Western Asset Management from 1979-2007)

 

Full article can be read here: http://scottgrannis.blogspot.com/2022/04/better-measures-of-yield-curve.html