Many economists say they’re worried about the economy, because the yield curve is flattening. The yield curve does have a good record of forecasting recessions ahead of time, but the details are important. In these times of unusual monetary policy, it’s important to take a close look at the details and the history. This blog post does that, and says there’s no reason to be worried about current activity in the yield curve.
In this second chart, you can see that those two interest rate differentials go negative before recessions. But there are a couple of episodes in the sample, in 1996 and 1998, when the yield curve is pretty flat, but there’s no ensuing recession. What’s different about those two episodes is that (see the first Chart) the compression is caused more by long bond yields moving down, rather than the short rate moving up, as we observe in the cases where compression precedes a recession. If you were worried about an oncoming recession right now, based only on yield curve observations, you shouldn’t be. All the recent flattening in the yield curve is in the long end. The margin between the two-year yield and the three-month T-bill rate hasn’t been falling, as it did prior to previous recessions.