It is well known the yield curve is an accurate predictor of recession and financial instability. When the yield of bonds and bills with shorter-term maturities are larger than that of longer-term maturities (the yield spread inverts), it is a clear indicator economic growth will decline in the near future. The general theory is covered here and is not worth rehashing further.
Typically, the yield curve is calculated by subtracting the 2-Y Treasury bond yield from that of the 10-Y Treasury bond. The US provides a case study for demonstrating the accuracy of the inverted yield curve as a predictor of recession, usually one to two years in advance.
The yield curve predicts the early 1980s double-dip recession, the early 1990s and 2000s recessions and the GFC. The latest data point as of 2017Q1 indicates there is no threat of a looming recession, as the yield curve has to hit zero and then invert for a recession to occur one to two years later.
The Australian data is also accurate. The quarterly 2-Y/10-Y public bond yield curve demonstrates the impending early 1980s recession, the near mid-1980s recession, the early 1990s recession and the GFC. It turns out there was plenty of warning for the GFC, with the yield curve turning negative in 2006Q2.
Using the 90-Day bill/10-Y public bond yield allows for superior detection of future downturns in economic growth, including rises in the unemployment rate. This yield curve picks up the small increases in the rate during the mid-1980s, 2001 and 2013/14, but these periods were not recessions. The mid-1970s recession is obvious.
A research paper by the RBA attempts to detect historical recessions while filtering out noise by employing standard econometric techniques. It concludes that “Because the coincident indices present a smoother perspective of the business cycle in the 1960s and 1970s, they identify fewer recessions in this period than does GDP. Over the past 45 years, the coincident indices locate three recessions – periods when there was a widespread downturn in economic activity; in 1974-1975, 1982-1983 and 1990-1991.”
The 2-Y/10-Y yield curve tends to identify the larger downturns in economic activity, while avoiding the smaller declines which did not have the intensity of these three major recessions. It appears the 90-Day/10-Y yield curve can detect both large and smaller declines in growth, which makes it valuable as well.
The long-term annual data (90-Day bill/10-Y public bond) provided plenty of warning of the looming 1890s depression, the worst economic downturn on record. It also portended the 1930s depression as well, though the inversion was not as large, and all other major downturns in the post-WW2 era.
Presently, the yield curve is indicating there is no recession on the horizon. This is despite anemic levels of real GDP growth, kept in positive territory only by our disgraceful population Quantitative Easing, public sector deficits, household sector dis-saving and record levels of private debt. Although shocks can swiftly make an impact, at face value, it appears the economy will keep lumbering through without recession any time soon.