Yield Curve Blurry? Try Out These Slowdown Predictors
(Bloomberg) -- Plenty of people who don’t follow bond market news heard about the time in March when a closely watched part of the yield curve inverted. That’s because such inversions -- instances when interest rates were higher for short-term loans than longer-term debt -- are rare. They’ve also generally presaged recession, which is why the news rocked the markets for a while. But some people, including Fed officials, believe that the yield curve may not be serving as a reliable signal in this instance. But there are other indicators that market observers follow for the same reason, and the current uncertainty about the yield curve makes them more important than usual. Here are a few:
Near-term forward spread
Bets placed now on short-term rates next year
- What it tracks: The difference between the so-called implied rate on three-month Treasury bills that mature six quarters from now and the current three-month yield. Essentially, it tracks short-term interest rate expectations. The implied rate is calculated by comparing the yield on three-month Treasuries maturing in 18 months (6 quarters) and in 21 months (7 quarters).
- What it shows: A negative reading suggests that traders are predicting that the Fed will lower borrowing costs over the next year or so. Since the Fed in the past has generally cut rates only when a recession was imminent, when this measure turns persistently negative, it would mean investors anticipate an economic downturn. A Fed research paper published in 2018 said that this gauge is likely better than more traditional yield curves, such as the gap between yields of two- and 10-year Treasuries, for predicting recessions.
- What it’s showing now: It fell to -24 basis points at the end of March, suggesting traders were pricing in about one Fed cut. This signal flashes amber.
- Alternatives: Eurodollar futures, which are tied to the three-month London interbank offered rate, are the most popular instrument for investors to bet on Fed policy. Other alternatives include Fed funds futures, which allow traders to speculate where the official Fed funds rate will be at the time of the contract expiry. Both contracts are suggesting that investors are expecting the Fed to cut rates.
Corporate bond spread
Looking for signs of a credit crunch
- What it tracks: The extra yields investors demand to hold corporate bonds instead of U.S. Treasuries.
- How it works: Higher rates for companies both reflect investor expectations for harder times ahead and help slow economic activity by making it harder for companies to get financing.
- What it is showing now: The credit spread measured by Bloomberg fell to 1.19 percentage point at the end of March, after jumping to an 2 ½-year high of 1.57 in December. It is at a level that suggests borrowing remains relative cheap -- the spread reached an all-time high of 6.18 percentage points in 2008. This signal is showing green.
- Alternative: Senior Loan Officer Survey. A quarterly loan officer survey conducted by the Fed that measures, among other things, the net percentage of bank officials who say they are tightening lending conditions. In February, the results showed that banks who tightened conditions outnumbered those who eased in January for the first time since 2016, but that loans are not in short supply. This light is also green.
Labor Differential Index in Consumer Confidence Survey
How tight is the labor market?
- What it tracks: The difference between those say jobs are plentiful in the Conference Board’s monthly consumer confidence survey and those who see jobs as hard to find.
- How it works: High readings for this indicator can signal the labor market’s peak -- meaning that higher unemployment could be coming. For example, the gauge reached an all-time high in July 2000, eight months before a recession started. In 2007, an economic contraction began just nine months after the index topped.
- What it is showing now: The differential index fell sharply in March, which could signal the labor market is about to cool off, a worrisome development.
- Alternative: Weekly initial jobless claims, which track the number of people filing for unemployment benefits, provides the most timely update on the status of the labor market. By this measure, the job market is still quite healthy -- the claims fell to the lowest since 1969 at the end of March.
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