Is the Yield Curve Signaling a Recession?

Thursday, March 24, 2016
yield curve
Thinkstock/rob freiberger

By Michael Owyang, Assistant Vice President and Economist, and Hannah Shell, Senior Research Associate

The yield curve plots rates on similar assets with different maturities, such as the 10-year U.S. Treasury note and the three-month U.S. Treasury bill. Typically, the difference between the rates (also called the term spread) is positive, meaning longer-maturity assets have a higher return than shorter-maturity assets. One reason for the positive spread is a liquidity premium. Securities with longer maturities are less readily able to be traded in for cash. The liquidity premium lowers the price on these bonds, which increases the yield (or return).

Yield curve inversions occur when the rates on short-term assets rise above long-term asset rates, leading to a negative yield spread. Assuming the liquidity premium has not changed, there are two primary reasons the spread could become negative:

  • Increased risk
  • Lower expectations about future outcomes, such as a recession

The risk premium of an asset is the premium associated with the difference in the likelihood of default of that asset over a risk-free asset. U.S. Treasuries are generally considered risk free. Thus, economists have previously linked inversions in the yield curve to recessions. For example, academic scholars,1 Federal Reserve economists2 and bloggers3 watch yield spreads closely, especially when the media is speculating about imminent recession.

The relationship between the yield spread and recessions has been borne out historically. The figure below shows the weekly yield spread (10-year Treasuries minus three-month Treasuries) from Dec. 1, 1981, to Feb. 1, 2016, with recessions, as defined by the National Bureau of Economic Research, shaded in gray.

Notice, in particular, that the yield spread turned negative before the beginning of the past three recessions. Declines in the yield spread are argued to signal economic slowdowns, but not all declines are associated with recessions. However, every case of a negative yield spread in the past 30 or so years has been followed by a recession within the next 12 months.

Numerous economists have tested the power of the yield spread in predicting recessions. In general, they find that the yield spread dominates other predictors at forecasting recessions. Estrella and Mishkin, for example, find that the yield curve beat other leading indicators for the 1990 recession.4 The figure demonstrates that a similar result would likely hold for the past two recessions.

Finally, notice that the current value of the yield spread is not negative. (In fact, it is strongly positive.) If the yield spread has truly become a harbinger of oncoming recession, rates would have to shift substantially prior to the onset of a recession.5

Notes and References

1 For example, see Estrella, Arturo; and Hardouvelis, Gikas. “The Term Structure as a Predictor of Real Economic Activity,” Journal of Finance, 1991, Vol. 46, Issue 2.

2 For example, see Estrella, Arturo; and Mishkin, Frederic S. “The Yield Curve as a Predictor of U.S. Recessions,” Federal Reserve Bank of New York Current Issues in Economics and Finance, June 1996, Vol. 2, Issue 7.

3 For example, see “Spreads and Recession Watch,” Econbrowser, Jan. 13, 2016.

4 Estrella, Arturo; and Mishkin, Frederic S. “The Yield Curve as a Predictor of U.S. Recessions,” Federal Reserve Bank of New York Current Issues in Economics and Finance, June 1996, Vol. 2, Issue 7.

5 One counterargument is that the short rate is historically low and that long rates cannot fall enough to produce a negative yield spread.

Additional Resources

Posted In Financial  |  Tagged michael owyanghannah shellyield curverecessiontreasuriesterm spreadliquidity premiumrisk premium
Commenting Policy: We encourage comments and discussions on our posts, even those that disagree with conclusions, if they are done in a respectful and courteous manner. All comments posted to our blog go through a moderator, so they won't appear immediately after being submitted. We reserve the right to remove or not publish inappropriate comments. This includes, but is not limited to, comments that are:
  • Vulgar, obscene, profane or otherwise disrespectful or discourteous
  • For commercial use, including spam
  • Threatening, harassing or constituting personal attacks
  • Violating copyright or otherwise infringing on third-party rights
  • Off-topic or significantly political
The St. Louis Fed will only respond to comments if we are clarifying a point. Comments are limited to 1,500 characters, so please edit your thinking before posting. While you will retain all of your ownership rights in any comment you submit, posting comments means you grant the St. Louis Fed the royalty-free right, in perpetuity, to use, reproduce, distribute, alter and/or display them, and the St. Louis Fed will be free to use any ideas, concepts, artwork, inventions, developments, suggestions or techniques embodied in your comments for any purpose whatsoever, with or without attribution, and without compensation to you. You will also waive all moral rights you may have in any comment you submit.
comments powered by Disqus

The St. Louis Fed uses Disqus software for the comment functionality on this blog. You can read the Disqus privacy policy. Disqus uses cookies and third party cookies. To learn more about these cookies and how to disable them, please see this article.

Subscribe to
On the Economy

Get notified when new content is available on our On the Economy blog.

Email Alerts  |  RSS

About the Blog

The St. Louis Fed On the Economy blog features relevant commentary, analysis, research and data from our economists and other St. Louis Fed experts.

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

Contact Us

For media-related questions, email For all other blog-related questions or comments, email