12 July 2019Financial Analysts JournalVolume 75, Issue 4
The Near-Term Forward Yield Spread as a Leading Indicator: A Less Distorted
Eric C. Engstrom
Steven A. Sharpe
The spread between the yields on a 10-year US T-note and a 2-year T-note is commonly used
as a harbinger of US recessions. We show that such “long-term spreads” are
statistically dominated in forecasting models by an economically intuitive alternative, a
“near-term forward spread.” This spread can be interpreted as a measure of
market expectations for near-term conventional monetary policy rates. Its predictive power
suggests that when market participants have expected—and priced in—a monetary
policy easing over the subsequent year and a half, a recession was likely to follow. The
near-term spread also has predicted four-quarter GDP growth with greater accuracy than
survey consensus forecasts, and it has substantial predictive power for stock returns.
Once a near-term spread is included in forecasting equations, yields on longer-term bonds
maturing beyond six to eight quarters have no added value for forecasting recessions, GDP
growth, or stock returns.
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Financial Analysts Journal
CFA Institute Member Content
CFA Institutedoi.org/10.1080/0015198X.2019.1625617ISSN/ISBN: 0015-198X
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