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Discussion Paper
The Term Spread as a Predictor of Financial Instability
The term spread is the difference between interest rates on short- and long-dated government securities. It is often referred to as a predictor of the business cycle. In particular, inversions of the yield curve—a negative term spread—are considered an early warning sign. Such inversions typically receive a lot of attention in policy debates when they occur. In this post, we point to another property of the term spread, namely its predictive ability for financial crisis events, both internationally and in historical U.S. data. We study the predictive power of the term spread for financial ...
Journal Article
Current Recession Risk According to the Yield Curve
The slope of the Treasury yield curve is a popular recession predictor with an excellent track record. The two most common alternative measures of the slope typically move together but have diverged recently, making the resulting recession signals unclear. Economic arguments and empirical evidence, including its more accurate predictions, favor the difference between 10-year and 3-month Treasury securities. Recession probabilities for the next year derived from this spread so far remain modest.
Report
Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates
Using a unique data set of individual professional forecasts, we document disagreement about the future path of monetary policy, particularly at longer horizons. The stark differences in short rate forecasts imply strong disagreement about the risk-return trade-off of longer-term bonds. Longer-horizon short rate disagreement co-moves with term premiums. We estimate an affine term structure model in which investors hold heterogeneous beliefs about the long-run level of rates. Our model fits Treasury yields and the short rate paths predicted by different groups of investors and thus matches the ...
Working Paper
Resolving the spanning puzzle in macro-finance term structure models
Previous macro-finance term structure models (MTSMs) imply that macroeconomic state variables are spanned by (i.e., perfectly correlated with) model-implied bond yields. However, this theoretical implication appears inconsistent with regressions showing that much macroeconomic variation is unspanned and that the unspanned variation helps forecast excess bond returns and future macroeconomic fluctuations. We resolve this contradiction?or ?spanning puzzle??by reconciling spanned MTSMs with the regression evidence, thus salvaging the previous macro-finance literature. Furthermore, we ...
Working Paper
Equilibrium Yield Curves and the Interest Rate Lower Bound
We study the term structure of default-free interest rates in a sticky-price model with an occasionally binding effective lower bound (ELB) constraint on interest rates and recursive preferences. The ELB constraint induces state-dependency in the dynamics of term premiums by affecting macroeconomic uncertainty and interest-rate sensitivity to economic activities. In a model calibrated to match key features of the aggregate economy and term structure dynamics in the U.S. above and at the ELB, we find that the ELB constraint typically lowers the absolute size of term premiums at the ELB and ...
Journal Article
The Fed’s Yield-Curve-Control Policy
The recent global financial crisis left governments in many advanced countries with very heavy debt burdens and their central banks with huge portfolios of government bonds. With many central banks today still facing policy rates that are uncomfortably close to zero, some may follow the example of Japan, which recently added a new long-term interest rate target to its short-term target to give itself ?yield-curve control.? The Federal Reserve?s foray into similar territory around the Second World War suggests that combining yield-curve control with quantitative easing when government ...
Briefing
Have Yield Curve Inversions Become More Likely?
The recent flattening of the yield curve has raised concerns that a recession is around the corner. Such concerns stem partly from the fact that yield curve inversions have preceded each of the past seven recessions. However, other factors affect the yield curve's shape besides the expected future health of the economy. In particular, a low term premium ? as has been observed in recent years ? makes yield curve inversions more likely even if the risk of recession has not increased at all.
Working Paper
Affine term structure pricing with bond supply as factors
This paper presents a theoretical model for analyzing the effect of the maturity structure of government debt on the yield curve. It is an ATSM (affine term structure model) in which the factors for the yield curve include, in addition to the short rate, the government bond supply for each maturity. The supply shock is not restricted to be perfectly correlated across maturities. The effect on the yield curve of a bond supply shock that is local to a maturity is largest at the maturity. This hump-shaped response of the yield curve persists in spite of the absence of preferred-habitat investors.
Journal Article
Yield Curve
Jargon Alert of the Yield Curve
Journal Article
Recession Prediction on the Clock
The jobless unemployment rate is a reliable predictor of recessions, almost always showing a turning point shortly before recessions but not at other times. Its success in predicting recessions is on par with the better-known slope of the yield curve but at a shorter horizon. Hence, it performs better for predicting recessions in the near term. Currently, this data and related series analyzed using the same method are not signaling that a recession is imminent, although that may change in coming months.