Ed Peters
March 30, 2022

There is much discussion about the inverted yield curve and what it means. Many are saying that an inverted yield curve, where short-term rates are higher than long-term rates, “always” precedes a recession. This bit of market lore, though, depends on a lot of basic definitions that are not often questioned. But I’ll give two: (1) which maturities on the yield curve are we talking about, and (2) what definition of recession are we using?

As for maturities, many use the 2-year/10-year yield spread, which has been narrowing. But the 30-day/10-year spread, another popular choice, has been widening. Meanwhile, Fed Chair, Jerome Powell, has stated that Fed research1 shows the 2/10-year spread results are probably spurious, and we should look at maturities of less than 2 years.

Meanwhile, what’s a recession? A popular definition is 2 quarters of negative GDP growth. But the NBER in the US has stated that they actually use multiple factors, and a committee decides if there is a recession. At the OECD, a recession is defined as growth slower than a long-term trend. So even the definition of what we’re trying to predict is ambiguous.

A while back, I decided to sidestep the ambiguity and revisit the three classic definitions of interest rate risk: slope (the 2/10-year spread), convexity (the 10-year yield minus the average of the 2/30-year spread) and the term premium. I found that it’s the trend in these factors that gives us our first clue as to what’s going on. Right now the trend suggests that the US economy is still growing and current Fed policy is not enough to cause a recession. Of course, things other than interest rates can cause a recession. That’s why the yield curve by itself is not enough to make such a forecast.

1“(Don’t Fear) the Yield Curve Reprise,” March 25, 2022.

Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss.
© First Quadrant, LLC, 2022. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, LLC, only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

Related Posts