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Why Does the Yield-Curve Slope Predict Recessions?

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  • Luca Benzoni
  • Olena Chyruk
  • David Kelley

Abstract

Many studies document the predictive power of the slope of the Treasury yield curve for forecasting recessions.2 This work is motivated, for example, by the empirical evidence in figure 1, which shows the term-structure slope, measured by the spread between the yields on ten-year and two-year U.S. Treasury securities, and shading that denotes U.S. recessions (dated by the National Bureau of Economic Research). Note that the yield-curve slope becomes negative before each economic recession since the 1970s.3 That is, an ?inversion? of the yield curve, in which short-maturity interest rates exceed long-maturity rates, is typically associated with a recession in the near future.

Suggested Citation

  • Luca Benzoni & Olena Chyruk & David Kelley, 2018. "Why Does the Yield-Curve Slope Predict Recessions?," Chicago Fed Letter, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhle:00093
    DOI: 10.21033/cfl-2018-404
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    References listed on IDEAS

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    1. Fama, Eugene F., 1986. "Term premiums and default premiums in money markets," Journal of Financial Economics, Elsevier, vol. 17(1), pages 175-196, September.
    2. Reuben A. Kessel, 1965. "The Cyclical Behavior of the Term Structure of Interest Rates," NBER Books, National Bureau of Economic Research, Inc, number kess65-1.
    3. Favero, Carlo A. & Söderström, Ulf & Kaminska, Iryna, 2005. "The Predictive Power of the Yield Spread: Further Evidence and A Structural Interpretation," CEPR Discussion Papers 4910, C.E.P.R. Discussion Papers.
    4. Rudebusch, Glenn D. & Williams, John C., 2009. "Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve," Journal of Business & Economic Statistics, American Statistical Association, vol. 27(4), pages 492-503.
    5. Estrella, Arturo & Hardouvelis, Gikas A, 1991. "The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-576, June.
    6. Michael D. Bauer & Thomas M. Mertens, 2018. "Economic Forecasts with the Yield Curve," FRBSF Economic Letter, Federal Reserve Bank of San Francisco.
    7. Andrea Ajello & Luca Benzoni & Olena Chyruk, 2012. "No-arbitrage restrictions and the U.S. Treasury market," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 36(Q II), pages 55-74.
    8. Andrea Ajello & Luca Benzoni & Olena Chyruk & Stijn Van Nieuwerburgh, 2020. "Core and ‘Crust’: Consumer Prices and the Term Structure of Interest Rates," The Review of Financial Studies, Society for Financial Studies, vol. 33(8), pages 3719-3765.
    9. Campbell, John Y. & Sunderam, Adi & Viceira, Luis M., 2017. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," Critical Finance Review, now publishers, vol. 6(2), pages 263-301, September.
    10. Ang, Andrew & Piazzesi, Monika & Wei, Min, 2006. "What does the yield curve tell us about GDP growth?," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 359-403.
    11. Harvey, Campbell R., 1988. "The real term structure and consumption growth," Journal of Financial Economics, Elsevier, vol. 22(2), pages 305-333, December.
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    Cited by:

    1. Martin Pažický, 2021. "Predicting Recessions in Germany Using the German and the US Yield Curve," Journal of Business Cycle Research, Springer;Centre for International Research on Economic Tendency Surveys (CIRET), vol. 17(3), pages 263-291, December.
    2. Massimo Ferrari Minesso & Laura Lebastard & Helena Mezo, 2023. "Text-Based Recession Probabilities," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(2), pages 415-438, June.
    3. Pawel Dlotko & Simon Rudkin, 2019. "The Topology of Time Series: Improving Recession Forecasting from Yield Spreads," Working Papers 2019-02, Swansea University, School of Management.
    4. Joseph G. Haubrich, 2021. "Does the Yield Curve Predict Output?," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 341-362, November.
    5. Eric Jondeau & Benoit Mojon & Jean-Guillaume Sahuc, 2020. "Bank Funding Cost and Liquidity Supply Regimes," BIS Working Papers 854, Bank for International Settlements.
    6. du Plessis, Emile & Fritsche, Ulrich, 2022. "New forecasting methods for an old problem: Predicting 147 years of systemic financial crises," WiSo-HH Working Paper Series 67, University of Hamburg, Faculty of Business, Economics and Social Sciences, WISO Research Laboratory.
    7. Sabes, David & Sahuc, Jean-Guillaume, 2023. "Do yield curve inversions predict recessions in the euro area?," Finance Research Letters, Elsevier, vol. 52(C).
    8. Matteo Iacopini & Aubrey Poon & Luca Rossini & Dan Zhu, 2024. "A Quantile Nelson-Siegel model," Papers 2401.09874, arXiv.org.
    9. Hansen, Anne Lundgaard, 2024. "Predicting recessions using VIX–yield curve cycles," International Journal of Forecasting, Elsevier, vol. 40(1), pages 409-422.

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    More about this item

    Keywords

    Interest rates; recessions;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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