Has the US yield curve inverted?

The U.S. Treasury yield curve has been flattening

Historically, the yield curve has inverted prior to recessions. Currently, the U.S. Treasury yield curve has been flattening with parts of it inverting. In particular:

• The spread between 5-year and 30-year Treasuries inverted on Monday March 28th. The spreads between 5-year and 10-year Treasuries as well as the spread between 3-year and 10-year Treasuries inverted last week;
• On the other hand, the spread between the 3-month Treasury bills and 10-year notes has been widening while the spread between the 2-year and 10-year Treasuries is close to inversion.

10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity

10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity

The predictive power of the inverted 2-10 spread

In this commentary, Engstrom and Sharpe provide statistical evidence indicating that the perceived predictive power of the 2-10 spread, that pervades market commentary, is probably spurious. Historically, the 2-10 spread and its inversions have not provided any incremental information about future economic conditions:

It is not valid to interpret inverted term spreads as independent measures of impending recession. They largely reflect the expectations of market participants. Among various terms spreads to consider, the 2-10 spread offers a particularly muddled view. Especially in the present circumstances when the 2-10 spread is very much out of step with the near-term forward spread, which offers a much more precise view of market expectations over the next year and a half, it is difficult to concoct a reason to be concerned about the flattening of the 2-10 spread.

(Don’t Fear) The Yield Curve, Reprise
By: Eric C. Engstrom, Steven A. Sharpe – Federal Reserve Board

The better predicting power of a “VIX-yield-curve indicator”

Anne Lundgaard Hansen in this paper argues that empirically one observes the VIX index and the slope of the yield curve to co-move through counterclockwise cycles that are aligned with the business cycle: recessionary periods are characterized by a combination of high levels of the VIX index and a flat yield curve. This relationship is robust and has repeated itself through all business cycles for which VIX index data are available. In broad terms, VIX-yield-curve cycles capture the interplay between financial markets and the stance of monetary policy.
The author constructs an indicator of the economy’s location on the VIX-yield-curve cycle. This cycle indicator is then used as a predictor in a probit model for the probability of recession within 6, 12, and 18 months. She finds that:

• The cycle indicator significantly outperforms the yield-curve spread in predicting recessions at all considered horizons;
• The predictive power comes from the interaction between monetary policy and corrections in financial markets rather than the co-movement
  between monetary policy and economic policy uncertainty.

Predicting Recessions Using VIX-Yield-Curve Cycles
Author: Anne Lundgaard Hansen
From: Federal Reserve Bank of Richmond