The Mystery of the Miniscule Term Spread

The Federal budget has just had a big hole blown in it, thanks to the Tax Cuts and Jobs Act and the last omnibus spending bill, the both the Fed and foreigners (including central banks) are no longer adding to their holdings of Treasurys.

First, consider that when structural (cyclically adjusted) budget deficits rise, often spreads rise. But not this time around.

Figure 1: 10 year-3 month Treasury spread (blue), structural budget deficit as a share of potential GDP (red). Orange shading denotes Trump administration. Source: Federal Reserve, CBO, Budget and Economic Outlook, and author’s calculations.

Not only is emission of government bonds rising, demand for government bonds is apparently tailing off.

Figure 2: Foreign and international holdings of US Treasurys (blue) and Federal Reserve holdings (red), both as a share of potential GDP. Source: BEA, CBO, and author’s calculations.

Running a Kitchen-Chinn (2012) specification augmented with expected annual growth from the Survey of Professional Forecasters (to account for the expectations hypothesis), yields:

Spread = 0.003 – 0.278(y-yn) – 0.197(inflgap) – 0.148(BuS) – 0.014(FedHold+FornHold) + 0.297(ExpGrowth)

Adj-R2 = 0.57, SER = 0.008, DW = 0.57, Bold denotes significance at 10% msl using HAC robust standard errors.

I find that the spread is over-predicted, by about half a percentage point.

Figure 3: 10 year-3 month Treasury spread (blue), predicted spread (red), spread plus/minus one standard error. Orange shading denotes Trump administration. Source: Federal Reserve and author’s calculations.

Could be just estimation error. Or the spread is falling because of factors not otherwise included in the regression (structural budget deficit, output gap, inflation gap, Fed and foreign Treasury holdings, and expected one year growth rates).

If the SPF median expectations signalled faster growth than market expectations, for instance, that might be one possibility.

30 thoughts on “The Mystery of the Miniscule Term Spread

  1. Moses Herzog

    Remember not terribly long ago (Oh yeah, another false scare thrown around during a Democrat administration) the false fear about China “not purchasing U.S. Treasuries” or the Chinese government “demanding their money back”?? When in fact there were few countries more desperate to get their hands on them. I know if I wasn’t commenting here many many many times that that was a false fear and a disingenuous attempt to create panic, I was “a broken record” playing that song over on James Kwak’s site (and I know Kwak agreed with me on this, as the smart observers did during that time)

    Now we have a REAL threat and a REAL scare, and a cause for, not panic, but serious concern. That reason for concern is—- multiple foreign banks and multiple foreign investors are showing much less interest in U.S. Treasuries. How often have we seen that before?? This is happening during a Republican administration and now you can hear a pin drop over the 2 whispers about tepid demand for U.S. Treasuries. Where have all the “panicked” man-children gone?? Strange how ‘the enemies of the people” in the “liberal biased” media wouldn’t want to talk about a very scary omen for U.S. markets created by trumpian and Republican tax policy designed as a large gift for corporations.

    No less of a “dirty liberal and socialist scum” website known as Zero Hedge recently said the following:
    “And while one could argue that the collapse in receipts is due to a 19% plunge in corporate income tax in the current fiscal year compared to last, which is indeed the case, it is just as concerning that Individual Income Taxes also posted a decline, dropping 3% to $372.8BN for the current fiscal year from $386.4BN in the prior period.”

    Thank god for the Koch brothers, Russian organized crime, trumpian golden showers on a Moscow hotel mattress, and Steve Bannon….. or I might start to worry where this country was going…… Nancy Pelosi is a very “strong” woman though, she’s very “strong” and she can clap so good. Pelosi can clap so good all the “mean girls” in white suburban high schools are practicing Pelosi’s clap now in the bathroom mirror. These high school “mean girls” don’t know shit about the negotiation and passage of legislation, but “strong” woman Nancy Pelosi has now taught them the ideal “mean girl” clap to be used by girls in white suburbia now. Now these girls are “strong”. “Strong” girls. “Strong” women.

    Keep saying it, keep repeating it, Nancy Pelosi is a “strong” woman!!!!! Help them Obi-Wan Rhetoric, you’re their only hope.

    1. baffling

      you may not like nancy, but she just made trump demonstrate he is a poor negotiator when he does not hold all the cards. his “success” in business was when he had the overwhelming advantage over his target-usually a small business. his numerous bankruptcies show he is not very talented when faced with an opposition of equal strength-his favorite option is simply to quit and walk away. trump ended up losing this negotiation with nancy and chuck, because you cannot simply quit and walk away when you are commander in chief. in fact, his “deal” is worse than what he was originally offered, and he owns the shutdown to boot. so his “negotiations” produced a negative result-not what one would expect from the master artist of the deal. this occurred because nancy did not give an inch. this is just the start. nancy raised five children, so she knows how to deal with a toddler who tries to hold his breath to get what he wants. the president is a toddler with a strong woman complex. the only concern is nancy may bring out even greater irrational tendencies from the toddler in chief. and he may have met his twitter match with aoc-younger folks are very social media savvy. i’m sure it burns him even more when its a woman.

  2. Moses Herzog

    I was going to go on another of my long tirades. Just going to ask a couple simple questions and leave you the highlights of some journalism. Is this what “strong” women do??

    Please tell me, what did the “strong” woman Nancy Pelosi get in return?? I lift a segment verbatim from the stellar journalism of SARAH FERRIS, MELANIE ZANONA and JOHN BRESNAHAN:
    Rep. Jim Jordan (R-Ohio), a key Trump ally in the hard-line House Freedom Caucus, cautiously predicted that Trump would sign the bill, then proceed with other avenues to obtain wall money. “My guess is, he might [sign it], kind of reluctantly, and then say we’re going to go with the emergency declaration. But I still think we could get something better,” Jordan said.

    The Freedom Caucus would rather pass a stopgap funding bill, which would keep Republican-negotiated spending levels from last year in place. The conservative group even introduced a one-week continuing resolution Wednesday afternoon.

    But Freedom Caucus Chairman Mark Meadows of North Carolina said conservatives won’t beat up Trump if he signs the border deal and takes executive action to free up more money for the wall. “If the president were to sign this bill based on the contours of what has been reported and suggested is in the bill, and did nothing else, it would be political suicide,” Meadows told reporters. “If he signed the bill… and takes other methods to obtain funding for additional border security measures, then I think there’s very little political liability from conservatives.”

    [edited MDC]

    Nancy Pelosi is a very “strong” woman. A very “strong” woman…… indeed………

    1. Dave

      Moses. I find your shrill criticism of Pelosi quite misplaced and strange. You seem resistant to most forms of Russian/RW propaganda and FUD, but you have a soft spot for anti-Pelosi rhetoric. What exactly would you want Pelosi to do here? She is Speaker of the house. All she can do is pass spending bills that the Senate (majority GOP) can agree on, and use her bully pulpit. That is her power in total. The GOP manages to do a lot of damage when in control of the house, because they would rather get nothing done and highlight Gov’t dysfunction. The Democrats have an interest in keeping the Govt running as smoothly as possible.

      On this particular issue, the whole emergency declaration thing is a joke and cannot happen. The GOP are just trying to say anything to keep their base from realizing how bad of a negotiator/deal-maker Trump is.

      1. dilbert dogbert

        Ah Dear Nancy! The internet was down this morning so I was scanning photos of the 1994 Chinese New Years Day Parade in San Francisco. When the children were home we used to go as a cheap means of entertaining them. I could yell insults at the local politicians as the passed in review. There was Wee Willy Brown and Nancy Pelosi.
        When the weather is wet and cold scanning old photos is one of my time wasters.

        1. Moses Herzog

          Speaking of the reliability (or the lack thereof) of ZH, they had some stories on Willie Brown’s supposed affair with Kamala Harris. The fact they were close is mentioned in a book written many years ago, prior to ZH ever existing. Would be interesting to know what part that played in her getting the District Attorney job and also why Harris never mentions his name even ONCE in her book. Brown was the Mayor there how many years?? His absence from the book almost seems to be a bigger red flag than if she had just mentioned him randomly a couple times.

          1. Barkley Rosser

            Oh, so now Kamala Harris is going to get on your list “mean girls” bad women who are either senile while inventing claps being imintated by all the young mean girls, are lying about their ancestry even though DNA evidence supports what they claimed, or are just not telling us everything. I mean, obviously whether KIH had an affair with WB or not (they apparently at least “dated”) is the most important thing in her history, and she must give us every gory detail of it, although this was apparently a couple of decades ago.

            Why is this important, Mose?

    2. Barkley Rosser

      Face it, Mose, Pelosi has fully defeated Trump, and everybody except apparently knows it. All this talk out of Jordan and Meadows is just face saving for Trump because they want him to sign this bill that has less money for his wall than he was offered back when he ordered a shutdown. They do not want another shutdown, so it is “maybe you can declare a national emergency” (which will end up bogged down in court) or “maybe you can move some money from one area to another to build the wall,” although that will run into Republican opposition when he tries to move money from areas they want spending on.

      You really are seriously deluded here. Pelosi is showing herself to be very smart and very strong, and everybody in the world knows it except for you, insane fool.

      1. pgl

        Trump is going to do two things. Sign the bill – yea. And attempt his emergency emergency declaration scam again. It seems Pelosi has in store a Congressional challenge to this national emergency declaration. Maybe Moses does not get but this Speaker rocks. She is giving a speech now – so time to listen.

    3. Barkley Rosser

      So now it looks like Trump will sign the bill and avoid a shutdown, although pushed by unhappy right wing supports such as Dobbs and Ingraham (a woman!) and Hannity, he will declare a national emergency in order to try to move funds around. This will certainly end up in court where most likely his effort will be blocked. it is being reported that Pelosi is considering what precisely to do, either to initiate more court action or introduce legislation to overturn his declaration, although that will probably not make it through the Senate or will be vetoed by him. But the courts will probably block him, which will give him an excuse to give his supporters unhappy at his total defeat at the hands of Mealy Clapping Girl Pelosi.

      I am going to add some personal knowledge on this. My niece is Erica Werner, check her out, Mose, a top reporter at the Washington Post. She covers Congress, and she has been the lead author of the top story on WaPo’s front page for the last five days in a row, basically the most knowledgeable reporter there is on what has been going down with respect to this whole shutdown/wall issue. She also covered the passage of the ACA back ;when Pelosi was previously Speaker. She knows the people in Congress about as well as anybody there is.

      So, you should not be surprised at the bottom line coming: she says that Pelosi is the smartest and most knowledgeable and most effective person in the entire Congress, her only rival being McConnell in the Senate, with the two of them essentially the masters of their respective Houses of Congress. You are just completely dead wrong about Pelosi, Mose. You could not be more wrong.

      BTW, I suspect your weird problem with smart and strong women has something to do with sick relationships with women in your family. However, for me, I have no problem with such women, with virtually all of the women in my family being brilliant and highly successful, and with whom I have good relations. Sorry your family life was apparently so messed up that you spout the seriously sick garbage you keep spouting.

  3. Abe

    OK I get it. I’m not an economics wonk so maybe this isn’t aimed at my understanding it. So a question and a suggestion

    1. Why do you use “potential GDP”? Isn’t potential another way of saying hypothetical or is it more factually based? And why use it instead of actual GDP?

    2. Menzie, could you differentiate the more econometric posts from the other policy oriented ones. Krugman as an example uses the term “wonkish” when he wants to give his audience a heads up.

    Just asking for some help with those of us who appreciate what you offer but sometimes feel a bit outside.

    1. Moses Herzog


      On a separate and unrelated note, couldn’t resist putting this up. I have mixed feelings about it, but Brainard is a very sharp cookie. When she says or writes something my first inclination is to agree with it, and while reserving the right to change my mind on this particular dillybopper, I would say at first glance she is correct on this as well.

      BTW, this plays along with my earlier prediction that I didn’t think there would be any more rate increases for the calendar year 2019. Maybe not terribly bold, but hey, I’ll take what I can get.

      1. David

        Moses. I suggest, for your own mental health, that you stop reading Zero Hedge. It is a known arm of the Russian propaganda psychological warfare operation. Sure, used to read it too because there is occasionally some interesting stuff in there. But it is really mostly just nonsense and propaganda.

        1. Moses Herzog

          There is no doubt or question as to the current state of my mental health. I have been obviously insane for awhile now. (roughly since 2005, but it gets fuzzy now the exact time frame due to certain recreational beverages taken during and since that time).

          In all seriousness, appreciate the reminder (and as sarcasm is hard to read online and I use the weapon often, I should tell you that is genuine appreciation for the heads up), I like to think ZeroHedge is slightly better than RT and Sputnik etc, but in reality, it’s kinda hard to say. Also like to think I can ferret out the more purely economics/finance/reality posts from the political/agenda/subjective posts. But where is that line on a website that has shown it doesn’t always value the truth?? It gets sticky.

          I appreciate the links David and they are food for thought, no doubt.

    2. Barkley Rosser


      I am prepared to say nice things when you change your tone/tune on some of these women you have dissed. So I modestly applaud your partial shift in tone on Governor Brainerd, although the use of “dillybopper” seems to be a continuation of an insulting and nonsensical view.

  4. csissoko

    The degree of rehypothecation of the bonds is a factor that could easily affect interest rates and might have a tendency to change when pressure for rising interest rates builds.

  5. pgl

    TalkingPointsMemo notes what Trump intends to do regarding the spending bill and THE WALL:

    In the comment section, “SPIN” gets the next steps:

    “What happens next is (1) a lawsuit is filed immediately, (2) Pelosi puts up a resolution disapproving the national emergency under the National Emergency Act, it passes (and puts every republican on the spot on an issue where Trump’s fascist plan gets 24% approval), and then (3) the senate MUST vote on the resolution, which can’t be filibustered. It will get 51 votes, the question is now many? It very well might get to 60+. Again, every republican senator is put on the spot”

    I join the rest of you in condemning Moses and his attacks on our female Speaker of the House. They are sexist and repugnant. And this drama here shows Pelosi is about to kick Trump’s royal rear end hard. Don’t get me wrong – Moses makes some smart comments here when he is not being an insanely stupid sexist. But attacking Pelosi on her resolve is beyond dumb.

    1. David

      Well, I’m worried I will turn out to be wrong in saying that the emergency declaration “cannot happen.” Obviously, we will see how the Senate votes, but if McConnell is “supporting it” I have to believe that he thinks he has the votes. Oh boy. Will Collins and Murkowski do the right thing? Who else is even likely to be on the fence?

      1. Moses Herzog

        @ David
        I’m not a big fan of “TPM” as I have seen them screw some things up before that weren’t that hard to get right.

        From what I am reading, the most likely scenario is this gets tied up in the courts over an extended period of time. For how long is it tied up in the courts??—that I have not scene a definitive answer on. The default answer would be “a very long time”, but how is it handled by the courts when labeled “a national emergency”?? That I do not know, but it’s a good bet we’ll see a lot of conjecture and educated answers over the next 2 weeks or more. Just think of how many people stated the Mueller investigation would be over by now. That’s a lot of incorrect calls by many people. Trump has two years to get this done, and when is “the first brick laid”, so to speak??

        1. pgl

          ‘I’m not a big fan of “TPM”’.

          Seriously? You are a lot like Trump. Is this the “fake news” dodge? Attack the news source since you cannot deny the actual news. Pelosi is indeed an effective leader even if you cannot stand that a woman can lead. Trump is a sexist idiot and it seems Moses shares this feature.

          1. Moses Herzog

            @ pgl
            I noticed you never seemed to make your shrill cries of hurt at my comments until I corrected you on your false interpretation of the ZTE situation being related to phones (it wasn’t related to phones, any idiot who can read knew it was 5G networks that were at the crux of the ZTE discussion), and your friend Barkley Junior showed he can’t tell the difference between data that is uniformly distributed and what he incorrectly called a “skewed” distribution. Of course, if Barkley Junior bothered to read the same papers he links to as sources, he could have saved himself A LOT of embarrassment, if he wasn’t already red-faced from quoting “Quora” links.

            I did enjoy your comments on Kelly Ann Conway and Sarah Huckabee though. But am perplexed why when I criticize female politicians I am a “sexist”, but when YOU criticize females you view yourself as “sweetness and light”?? I am sorry to tell you “cinnamon and spice and everything nice”, Hillary lost because she’s a crappy politician. Just like Elizabeth Warren is going to lose as she’s already shown she’s no good at campaigning either. Had she not LIED about being “Native American” with less than 1.57% of her DNA being such, maybe it would have been different. I would have liked to see her make a go of it, but I have no interest in supporting people who LIE about their own biography.

            BTW, I would have been happy to say I was wrong on Pelosi, and make a semi-apology to the woman, had she not handed a $1.4 Billion dollar Valentine’s Day gift to donald trump. But, she proved me correct, as she largely has over the second portion of her 17 years of “leadership” when I saw Pelosi for what she truly is: a frail, delicate “leader” who has no idea how to wage political war, and who majors in “mean girl” clapping. She’s very good at clapping though, or so the pundits have told me. if I ever need a “mean girl” clapper when fighting legislative wars, I promise, I would phone Pelosi first thing.

          2. Barkley Rosser

            I said I would not revisit those matters, but since you keep repeating your inane comment about distributions as if somehow you won an intellectual point, and you somehow think that dragging my brilliant late mathematician father in as if to somehow shame me, well, let me simply note, preferably really for the last time, that it has been pointed out many times not only by me but by several others here, that an even distribution across a genome is not the same thing as an even distribution across a population, and the former does not remotely imply the latter, with the article in question that you keep mentioning only talking about an even distribution across the genome, while the relevant question under discussion was the distribution across population. You could not be more wrong and misguided in all your comments on this matter, unwilling as you clearly are to admit it.

            I must tell you that my late father was not only better at math than I am (he hung around with the likes of Gödel, von Neumann, Erdos, Church, Kleene, and Einstein), but he was also much more pompous and far less tolerant of people messing up on math than I am. If you were to have made any of these incredibly stupid and ignorant comments in his presence, he would have flushed you down the toilet so fast you would not even have had a chance to grab a shred of toilet paper before you went down.

  6. Moses Herzog

    Flake and McCain are gone. So is Bob Corker. None of the 3 had any ethics, but it just “got personal” with donald trump for them I think, so they just wanted to spit a loogie in trump’s lunchtime Big Mac. Ben Sasse strikes me as a guy with a little bit more backbone than your average Republican. In fact I would trust Sasse more than Collins to diverge from trump. Collins is in the same camp as Pelosi, only I’m guessing Collins has Parkinson’s instead of Alzheimers. Either way she’s a useless sack of crap in my book. Ben Sasse at least could still tell you his children’s names, so that’s always a plus. If you’re just referring to funding alone, that still has to get through the House I think, and unless Pelosi wants to give donald trump another back-rub and a neck hickey like she did together with this $1.4 Billion Valentine’s day gift from the San Fran Alzheimer’s Ward, I don’t see how Orange Excrement gets the funding passed from the House.

  7. baffling

    a couple of years ago, i would have bet if obama had acted like emperor and taking the executive action that trump has proposed, the republican controlled congress would have had fits of rage for years. and yet today mostly i hear crickets from the conservatives and the senate. why is that? trump lied about wanting to be president, he really wanted to be emperor. just needed the election to get his foot in the door. i bet rick stryker is applauding this power grab by the toddler in chief to become the next little emperor, since the lie (and the con) were so effective. all those conservatives who worried about executive overreach in the past have been had, and are still too stoopid to realize it. so much for conservatives protecting democracy and the constitution.

  8. pgl

    “Moses Herzog
    February 15, 2019 at 9:38 am
    @ pgl
    I noticed you never seemed to make your shrill cries of hurt at my comments until I corrected you on your false interpretation of the ZTE situation being related to phones”

    ZTE is your excuse for sexist comments now? Look dude – I stopped reading your long winded rants a long time ago. Which is a shame as you on occassion make some good points. There is NO excuse for your sexism. And BTW – I did not read the rest of your latest rant. Life is short and there are more important things to do.

  9. macroduck

    I don’t find any recent estimates of the cyclically adjusted deficit at the CBO site. FRED doesn’t seem to have the series either. So is that where “author’s calculation” comes in? Wouldn’t mind having a look at the data.

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