A lot attention has been paid to the
yield curve recently, specially the 10 years minus 2 years US
treasure spread (spread). In fact many papers have been written on
the subject and the important prediction function that the spread has
on US economic cycles and recession. However since the introduction
of the ZIRP the nature of the spread seems to have changed. Looking
through the data since 1978 until ZIRP its possible to notice that
the most important driver of the spread has been the short term
interest rate, more specifically the Fed funds, and not the long
tail. But after ZIRP things changed and because the short term is
anchored by the Fed funds the spread has been driven by the long
tail. So, looking for the spread nowadays could be misleading in
terms of recession prediction. Sure a recession is always possible but this
time it wont be caused by the usual driver of the spread, what
reduces its importance in my view.
Fed Funds, curve flattening and
recessions:
the flattening of the curve and FED
funds hiking cycle is very similar. But to measure better the effect
of Fed Funds and the 10 Years UST on the spread I ran a couple o
simple regressions below.
First the impact of FED Funds on the
spread since 1978:
and from 1978 until 2007 just before
the crisis...
things are pretty much different for
the UST 10Y:
However, since 2010 things changed and
UST is the main driver of the spread now, not surprisingly once the
2Y has been anchored by the Fed funds.
What can be seen here also...
If the the spread is important because
most of it is driven by the short term rates it must be important to
question its meaning now that the driver has changed. NBER has a
paper that through a much deeper analyzes also finds more prediction
power on the short term rates instead
(http://www.nber.org/papers/w10672.pdf).
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