The 2-year/10-year spread is the difference between long-term and short-term bonds. When long-term yields fall below short-term yields, this is arguably the most accurate indicator of a looming recession.
The yield curve has been falling since the beginning of 2014 and has reached its lowest point in almost 11 years, falling to just 47 basis points this week.
The yield curve has been falling by around 6 basis points a month since the beginning of 2017. On this trajectory, the bond yield spread will turn negative before the end of this year.
Historically, the bond yield turns negative around 9-12 months before the beginning of a recession. In fact, an inverted yield curve has proceeded every recession since the 1950’s.
Earlier this month economists Thomas Merterns and Michael Bauer at the Federal Reserve Bank of San Francisco noted that an inverted yield curve “reliably predicts low future output growth and indicates a high probability of recession".
If the bond yield spread does continue on its current downward trajectory, then perhaps my pervious prediction of a looming recession in Q4 2019 will prove to be more accurate that previously calculated. It will be interesting in the coming weeks and months to watch the trajectory of the 2-year/10-year bond yield spread.