WASHINGTON–While the data has long been a standard, some analysts, including at the Federal Reserve, are questioning whether yields on government bonds and the yield curve are the best predictors of recessions.
The reason is that while bond yields have been among the most accurate of forecast tools in the past, those predictions came while the economy was weakening, not strengthening as it has been. As a result, minutes of the Fed’s June policy meeting reveal the central bank considered an alternative approach to avoid some of the shortcomings of using bond yields, according to the New York Times.
“The bond market indicator in question is the yield curve, which tracks the yields on Treasury securities that are repaid after different periods,” noted the Times. “The yields on the Treasuries that are repaid in two years are usually lower than those that are repaid…in 10. But sometimes, as is now the case, the difference between the yields on two-year and 10-year Treasuries narrows. This week, the spread between the two bonds was only 0.3 percentage points.”
‘Less Useful Predictor?’
When the yield curve has inverted in the past, a recession has followed. But the Times reported that changes in the bond market and economy may have made the yield curve a “less useful predictor.”
“The Fed and other central banks bought huge amounts of government securities after the financial crisis, which raised their prices and reduced their yields. Those purchases may still be holding down yields,” said the Times in its analysis. “In addition, investors appear to believe that there is less risk of inflation in the global economy these days, which makes Treasuries more appealing. At the same time, the Fed has been raising short-term interest rates, and is expected to keep doing so through at least next year.”
During its most recent meeting, members of the central bank’s staff gave a presentation in which they used readings from another market to predict the likelihood of a recession, according to the minutes, the Times reported.
“They looked at the current interest rate in the federal funds market, in which banks borrow from and lend to each other overnight, and compared that with the fed funds rates predicted in the futures markets. The minutes said: ‘The staff noted that this measure may be less affected by many of the factors that have contributed to the flattening of the yield curve.’”
But one analyst told the Times the Fed’s forecast is flawed, noting the fed funds rates may be strongly influenced by the Fed’s own guidance for that rate. “The Fed is analyzing its own footprints,” Jim Vogel, a debt markets strategist at FTN Financial, told the Times.