The Yield Curve As A Predictor Of Future Growth

from the St Louis Fed

-- this post authored by Matthew Famiglietti, Research Associate; and Carlos Garriga, Senior Vice President and Director of Research

In recent weeks, the steepening yield curve has become a topic of conversation among market participants. For starters, the slope of the yield curve can be measured as the difference in nominal interest rates between long- and short-term U.S. Treasury securities. Using the spread or difference between the 10-year and two-year constant maturity Treasury rates (the most common maturities used when referencing the yield curve), the difference in these yields has more than doubled from an average of 0.48% in July 2020 to 1.14% in February 2021. This increase in a spread has been driven entirely by an increase in nominal yields on the 10-year Treasury note, as the Federal Reserve through open market operations has driven the yield on two-year notes very close to 0%.

Why Are 10-Year Yields Rising?

What does the increased nominal yield on the 10-year note imply, and why is it a source of angst for financial markets? One view is that the increase in 10-year yields is driven by a belief in the financial markets that fiscal and monetary stimulus throughout the COVID-19 pandemic, together with the timely arrival of vaccines, has been enough to generate expectations of higher economic growth in the future.

Another view is that under the new framework for monetary policy, a seemingly positive economic expectation is causing the fear that this growth will generate higher inflation rates than those witnessed in the last decade.

The increase in nominal yields may be problematic for future growth as borrowing costs with longer maturity dates tend to increase with Treasury yields, and this phenomenon makes long-term investment more costly.

In this post, we explore what implications the recent movement in the yield curve may have for future growth. It is common to use data from financial markets to try to extract information about the future performance of the economy. In a series of posts in 2018 and 2019, we discussed the significance of yield curve inversions as a leading indicator of U.S. recessions.[1] We also examined which economic indicators are leading indicators of economic cycles and which ones have some predictive power over the slope of the yield curve.[2]

1 2 3
View single page >> |

Disclaimer: Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

No content is to be construed as investment advice and all ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.