Using the yield spread to forecast recessions and recoveries

By ft Editorial Staff • Jul 1st, 2011 • Category: Charts, December 2010 Journal

This article presents the yield spread as a tool for brokers and their agents to use in forecasting future economic conditions facing the real estate market.

Chart last updated 7/1/11

  May 2011 April 2011 May 2010
Yield Spread

The blue line on the chart above tracks the yield spread: The difference between the ten-year Treasury note (or long-term interest rate) and the three-month Treasury bill (or short-term interest rate).

The following numbers correspond to the numbered boxes on the chart above.

  1. Vertical gray bars indicate periods of recession.
  2. The green line is the recession threshold: the point for which the probability of recession begins, as assigned by Federal Reserve (Fed) economists. Under the Fed’s analysis, yield spreads smaller than 1.21% predict successively greater probabilities of recessions one year forward.
  3. The orange line in the chart represents zero. When the yield spread dips below zero, or in other words when the long-term rate is lower than the short-term rate, an inversion of the two key interest rates has occurred. Yield spread inversion signals a disturbance in the two rates controlling the yield—and presages a recession approximately one year forward.