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Yield Curve Inversions and Yield Curve Inversions and Future Economic GrowthFuture Economic Growth

Campbell R. HarveyDuke University, Durham, NC USA

National Bureau of Economic Research, Cambridge MA USA

cam.harvey@duke.edu+1 919.660.7768 office || +1 919.271.8156 mobile

http://www.duke.edu/~charvey

May 20, 2010

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Issue

• How long will this recession be?

• I pioneered in my 1986 dissertation at the University of Chicago a recession prediction model linked to the term structure of interest rates

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Historical Track Record

• Yield curve measure attracted significant attention in accurately forecasting the last seven recessions

• The measure also avoided false signals (for example, it forecasted strong growth in 1988 after the October 1987 crash and it forecasted strong growth in 1999 after the August 1998 financial crisis).

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Yield Curve Inverts Before Recessions(5-year Treasury note minus 3-month Treasury bill yield – constant maturity)

-6

-4

-2

0

2

4

6

8

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

% Real annual GDP growth

Yield curve

RecessionCorrect 2 Recessions

Correct

RecessionCorrect

Annual GDP growthor Yield Curve %

Data though December 1986

Source: Campbell R. Harvey. Update of Harvey (1986, 1988, 1989, 1991).

Dissertationpublished in 1986

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Yield Curve Inverts Before Last Seven Recessions(5-year Treasury note minus 3-month Treasury bill yield – constant maturity)

-6

-4

-2

0

2

4

6

8

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

% Real annual GDP growth

Yield curve

RecessionCorrect 2 Recessions

Correct

RecessionCorrect Yield curve accurate

in previous recessionRecessionCorrect

Annual GDP growthor Yield Curve %

Data though May 2010Source: Campbell R. Harvey. Update of Harvey (1986, 1988, 1989, 1991).

Correct oncurrentrecession

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Recent Annualized One-Quarter GDP Growth (10-year and 5-year Yield Curves-secondary market)

-8

-6

-4

-2

0

2

4

6

8

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

-4

-3

-2

-1

0

1

2

3

4% Real annualized one-quarter GDP growth

Annualized 1-quarter GDP growth

Both curvesinvert 2000Q3

10-year

5-year

Yield curve

Data though April 11, 20103% growth assumed for 2010Q1

Forecasts long recession

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Evaluating the 2001 Recession

• In July 2000, the yield curve inverted forecasting recession to begin in 2001.

• Official NBER Peak is March 2001.

• In March 2001, the yield curve returned to normal

• Inversion length = 9 months

• Forecast recession trough November 2001.

• On July 17, 2003 the NBER announced the official end of the recession was November 2001.

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Evaluating the 2008-09 Recession

• In January 2006, the yield curve inverted forecasting recession to begin in 2007.

• Official NBER Peak is December 2007.

• In August 2007, the yield curve returned to normal.

• Inversion length = 20 months indicating long recession.

• Forecasts the end of the recession in August 2009.

• We need to wait and see.

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Exhibit 1

Lead Lag Analysis in Months

NBER Peak

NBER Trough

Length of Cycle Inversion Lead Normal Lead

Length of Inversion

Dec-69 Nov-70 12 Oct-68 15 Feb-70 10 17Nov-73 Mar-75 17 Jun-73 6 Jan-75 3 20Jan-80 Jul-80 7 Nov-78 15 May-80 3 19Jul-81 Nov-82 17 Oct-80 10 Oct-81 14 13Jul-90 Mar-91 9 May-89 15 Feb-90 14 10

Mar-01 Nov-01 9 Jul-00 9 Mar-01 9 9Average last six 12 12 9 15

Current EpisodeDec-07 ? ? Jan-06 Aug-07 20

Business Cycle 5-Year Yield Spread

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Current Recession Forecast

• In the first quarter 2006, the Yield Curve inverts for 20 months

• Lead time to NBER Peak is 9-15 months over last six business cycles

• Model predicts recovery beginning August 2009– Length of recession projected to be more than double that of

previous two recessions

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Yield Curve and GDP Research Chronology

• Campbell R. Harvey’s Ph.D. Thesis, University of Chicago, 1986.

• Campbell R. Harvey, “The Real Term Structure and Consumption Growth,” Journal of Financial Economics, 1988

• Seven other articles found at:

http://www.duke.edu/~charvey/research_term_structure.htm