yield curve

My inbox is filled with commentary on the yield curve today after a series of inversions, particularly 3s10s and 5s30s.

An inversion of the yield curve is a classic recessionary signal but which part of the yield curve needs to invert is a hotly-debated matter. The classic view is that the difference between the 2-year and 10-year yield is what matters.

On Friday, the Fed dusted off and updated a paper arguing that 2s10s don't signal anything.

"We have provided statistical evidence indicating that the perceived omniscience of the 2-10 spread that pervades market commentary is probably spurious," authors Eric Engstrom and Steven Sharpe write. "We argue there is no need to fear the 2-10 spread, or any other spread measure for that matter."

What's notable is that this report updates a similar one from the same authors in 2018. Just a few months after that, everything inverted and we had a pandemic recession.

It's also notable that curves in many countries have inverted without recessions.

What the paper argues is that the spread between 3-month bills and the yield on 18-month forwards bills is more telling. They call this "the near-term forward spread."

That spread is currently about 220 basis points and in no danger of inverting.

As you can see, it appears to be a good leading indicator of US recessions:

near term foreward spread

At the same time, it only really tells you that the Fed is going to cut rates, which is something you can glean from Fed funds futures.

In any case, expect this debate to rage in the months ahead.

I maintain that there's no magical way to forecast a recession. A pandemic caused the last recession, not an inversion of the curve that happened in March 2019 -- many months before any hint of covid. And there was plenty of opportunity to put in pandemic trades after the inversion.

near-term forward spread vs 2s10s