Many people believe that the Yield Curve is an important economic indicator.

On March 1, 2010, I wrote a post on the issue, titled “The Yield Curve As A Leading Economic Indicator.”

An excerpt from that post:

On the NY Fed link above, they have posted numerous studies that support the theory that the yield curve is a leading indicator.   My objections with using it as a leading indicator, especially now, are various.  These objections include: I don’t think such a narrow measure is one that can be relied upon;  both the yields at the short and long-end of the curve have been overtly and officially manipulated, thus distorting the curve; and, although the yield curve may have been an accurate leading indicator in the past, this period of economic weakness is inherently dissimilar in nature from past recessions and depressions in a multitude of ways – thus, historical yardsticks and metrics probably won’t (and have not) proven appropriate.

While I continue to have the above-stated reservations regarding the “yield curve” as an indicator, I do believe that it should be monitored.

As an indication of the yield curve, below is a weekly chart from January 1, 1990 through April 10, 2018.  The top two plots show the 10-Year Treasury and 2-Year Treasury yields.  The third plot shows the (yield) spread between the 10-Year Treasury and 2-Year Treasury, with the April 10, 2018 closing value of .48%.  The bottom plot shows the S&P500:

(click on chart to enlarge image)(chart courtesy of StockCharts.com; chart creation and annotation by the author)

Additionally, below is a chart showing the same spread between the 10-Year Treasury and 2-Year Treasury, albeit with a slightly different measurement, using constant maturity securities.  This daily chart is from June 1, 1976 through April 9, 2018 (updated April 10, 2018) with recessionary periods shown in gray. This chart shows a value of .49%:

source:  Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity [T10Y2Y], retrieved from FRED, Federal Reserve Bank of St. Louis; accessed April 11, 2018:

https://research.stlouisfed.org/fred2/series/T10Y2Y

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2656.87 as this post is written

While I do not agree with the current readings of the measure – I think the measure dramatically understates the probability of deflation, as measured by the CPI – the Federal Reserve Bank of Atlanta maintains an interesting data series titled “Deflation Probabilities.”

As stated on the site:

Using estimates derived from Treasury Inflation-Protected Securities (TIPS) markets, described in a technical appendix, this weekly report provides two measures of the probability of consumer price index (CPI) deflation through 2022.

A chart shows the trends of the probabilities.  As one can see in the chart, the readings are volatile.

As for the current weekly reading, the April 5, 2018 update states the following:

The 2017–22 deflation probability was 0.8 percent on April 4, up from 0.4 percent on March 28. The 2016–21 deflation probability was 2.5 percent on April 4, up from 2.0 percent on March 28. These deflation probabilities, measuring the likelihoods of net declines in the consumer price index over the five-year periods starting in early 2016 and early 2017, are estimated from prices of the five-year Treasury Inflation-Protected Securities (TIPS) issued in April 2016 and April 2017 and the 10-year TIPS issued in July 2011 and July 2012.

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I post various economic indicators and indices because I believe they should be carefully monitored.  However, as those familiar with this site are aware, I do not necessarily agree with what they depict or imply.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2662.84 as this post is written

There are a variety of economic models that are supposed to predict the probabilities of recession.

While I don’t agree with the methodologies employed or probabilities of impending economic weakness as depicted by the following two models, I think the results of these models should be monitored.

Please note that each of these models is updated regularly, and the results of these – as well as other recession models – can fluctuate significantly.

The first is the “Yield Curve as a Leading Indicator” from the New York Federal Reserve.  I wrote a post concerning this measure on March 1, 2010, titled “The Yield Curve as a Leading Indicator.”

Currently (last updated April 5, 2018 using data through March) this “Yield Curve” model shows a 10.8366% probability of a recession in the United States twelve months ahead.  For comparison purposes, it showed a 9.1421% probability through February, and a chart going back to 1960 is seen at the “Probability Of U.S. Recession Predicted by Treasury Spread.” (pdf)

The second model is from Marcelle Chauvet and Jeremy Piger.  This model is described on the St. Louis Federal Reserve site (FRED) as follows:

Smoothed recession probabilities for the United States are obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales. This model was originally developed in Chauvet, M., “An Economic Characterization of Business Cycle Dynamics with Factor Structure and Regime Switching,” International Economic Review, 1998, 39, 969-996. (http://faculty.ucr.edu/~chauvet/ier.pdf)

Additional details and explanations can be seen on the “U.S. Recession Probabilities” page.

This model, last updated on April 2, 2018, currently shows a 1.54% probability using data through January.

Here is the FRED chart (last updated April 2, 2018):

Data Source:  Piger, Jeremy Max and Chauvet, Marcelle, Smoothed U.S. Recession Probabilities [RECPROUSM156N], retrieved from FRED, Federal Reserve Bank of St. Louis, accessed April 5, 2018:

http://research.stlouisfed.org/fred2/series/RECPROUSM156N

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The two models featured above can be compared against measures seen in recent blog posts.  For instance, as seen in the March 15 post titled “The March 2018 Wall Street Journal Economic Forecast Survey“ economists surveyed averaged a 13.66% probability of a U.S. recession within the next 12 months.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 2663.57 as this post is written