Fun with the Yield Curve

The bond yield curve is an economic predictive tool that only began to be generally appreciated in the 1990’s, and there’s a great Java Applet that allows you to look at the yield curve for any time during the last several years here.

A short course on using the applet: The right-hand graph shows the S&P 500, and there is a movable vertical line (red), that you can drag left or right to pick a moment in time.

The left graph displays the Yield Curve for the point in time selected by the slider on the right graph. Its Y axis shows interest rates, and its X axis has the term length of the Treasury bill: short-term bills on the left, stretching out to 30-year bills on the right). You can also adjust the “Trail Length” slider on the left graph, which controls “the length of the comet’s tail” — how many days’ worth of preceding yield curves show up as shadows. If you drag that “Trail length” slider all the way left, you get just a sharp line, and as you drag it more to the right, you see a more fuzzy area showing you where it had been in the few days before the time shown.

Now, when we speak of a “flat yield curve”, or an “inverted yield curve”, we usually are comparing, say, the 3-month Treasuries with 10-year Treasuries, or perhaps 2-year vs. 10-year.

So, drag the slider on the right-hand (S&P 500) graph to 3 August 2000 or so (the date is displayed on the left graph, while you’re selected it on the right graph), near the S&P peak. Now look at the yield curve on the left graph. Compare the short-term yields to the 10-year yields. It’s become flat, actually a little downward-pointing. That’s bad: 5 out of the last 6 times, that’s meant recession, starting 2 to 6 months out. Officially, the recession started in March 2001 (6 months later), but I know that data switch sales fell off a cliff in December 2000 (3 months later), so that was a pretty good indicator.

As you drag the date/time slider on the right graph towards the right, the yield curve (looking only at the short-term to 10y segment) doesn’t start looking more normal until about a year later, around August 2001, and by 18 January 2002 is looking very positive. The recession didn’t officially end until November 2002, though, so that’s much more of a lag.

Now, let’s look at the spread between the shortest-term bills and the longer term bills on several different dates:

              Short vs. 10Y
08/03/2000        -0.25% First Inversion
12/08/2000        -0.50% Data Switch Sales Plummet
01/02/2001        -0.75% Recession Still Quite Not Official
03/19/2001        +0.25% Recession Official
(But Note That S&P 500 Had Already Fallen About 300 Points Aug-Mar)

04/05/2002        +3.50% After several aggressive Fed Moves
Much of 2002-2003 +2.00% S%P sputtering up and down here.
Last part of 2003 +3.00% Gaining Steam
05/11/2004        +4.00% Wow! Pre-election Impetus?
02/18/2005        +1.25% Much Flatter, But Still Positive
12/07/2006        Oh, it's flat.

Oog, flat yield curve, housing bubble popping – be wary, and if it inverts for a sustained period, look out below!

(Edited to reflect Chris Gibson’s corrections)

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3 thoughts on “Fun with the Yield Curve”

  1. That’s a truly-neat graphic. I especially enjoyed the animated version.

    However, I should want to point out that today’s yield curve is generally considered “flat” rather than “inverted”; this is still a cause for concern, and recently, the WSJ reported that economists from the Swiss Reinsurance Co. (a world leader in risk analysis) are putting the chance of recession in “the coming quarters at about 35%,” based both on the fundamentals indicated by the current yield curve and the pressures of the weakening housing market.

    They also mentioned that the prediction of recession by the New York Fed puts the odds at 40% (this is based purely on a technical analysis of the yield curve); I found this interesting in comparison to Fed Chairman Bernanke’s recent, typically vague and pseudo-reassuring comments regarding an economy in “deceleration…roughly along the lines envisioned.”

    So, don’t horde gold just yet, but it’s probably not a good time to make a stretch to buy that yacht you’ve been eyeing.

  2. Very cool, Tom — thanks for posting it!

    The Yield Curve is indeed a useful tool to detect when the next bust phase of the Business Cycle begins — unless the central bank can respond quickly enough to start the next round of credit expansion, which then begins the next boom.

    But to me, all this does is expose the great lie of fiat money, fractional reserve banking and central banking. When money no longer is backed by a real commodity,

    Of course, all of this begs the question:

    Should the price of money be manipulated by Treasury bureaucrats, or should market forces — supply and demand — be allowed to determine its price?

    Which begs another question:

    Since “money” today is really fiat money, and its supply is ultimately in the hands of central bankers and fiat currency,
    What is money today?

    The entire planet is now long into the modern era of fiat currency — money that has no intrinsic value, its value being declared by government fiat. It’s money simply because the law says it is, and everyone goes along with it. So far.

    Only the Austrian School economists have predicted the inevitable mega-booms and mega-busts that come from the modern fiat money, fractional reserve, central banking system.

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