The Near-Term Forward Yield Spread as a Leading Indicator: A Less Distorted Mirror

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. The authors Eric C. Engstrom and Steven A. Sharpe 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. 

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