Reader Steven Kopits opines on the CBO projection: “by historical standards [1982-2007], we might expect the 10 year rate around 5.0% for the next decade”. I thought it useful to look at the data:
First the ten year Treasury yield.
Figure 1: Ten year Treasury yields, % (blue). NBER defined peak to trough recession dates shaded gray. Source: Treasury via FRED, Shiller database, CBO (January 2025), and author’s calculations.
I’d say it ill-advised to take the sample mean from 1982-2007 as representative. Here’s the spread.
Figure 2: 10yr-3mo Treasury spread, % (blue). NBER defined peak to trough recession dates shaded gray. Source: Treasury via FRED, NBER historical series, Shiller database, CBO (January 2025), and author’s calculations.
While I think comparing short and long term Treasury rates is a useful tool, it is not the be all and end all.
In the first place, there was no inverted yield curve between the Discount or Fed Funds rates and long term government bonds at any time between 1931 and 1958, and yet there were a number of recessions during that time including the deep 1938 recession primarily caused by fiscal tightening.
Secondly, the Fed is a human actor with concentrated economic power. That means it can be foolish or smart, and later Fed’s can learn from the mistakes of earlier Fed’s. Hence, one of the best forecasting headlines I’ve ever read: “The Fed wants to make your recession forecast wrong.” This is what Yuval Harari’s calls second order chaos, I.e., when you observe the humans, they always observe back.
The difficulties with the yield curve is why it is not an element of ECRI’s forecasting system. Rather, they look broadly at the level of interest rates, historically found in the (former) Dow Jones Bond Index.
In the past a correspondent gave me a heads up about historical commercial paper rates. These can be found in data going all the way back to the Civil War. Sure enough, a pronounced increase in commercial paper rates was a very good indicator for recessions ahead.
I have not been able to trace long term treasuries back before 1924. I would be interested to see what a graph of commercial paper vs. 10 year treasuries looks like before then, or else a link to the location of the source data for that period, if Prof. Chinn is willing to do so. Because it looks like there were extended periods of inversions between 1870 and 1900 in particular – and lots of recessions too.
Here is a link to the graph of the ancestral interest rates I have referred to in this comment:
https://fred.stlouisfed.org/graph/?g=1D6pc
Exactly right about the Fed. If we are to use spread averages as a forecasting tool, we might want to consider whether the Fed has changed its behavior in managing interest rates, and when changes have occurred. Some pretty smart people think that the Fed, and some of the Fed’s relatives, went from a system of scarce reserves to abundant reserves in response to the mortgage crash:
https://cepr.org/voxeu/columns/double-faced-demand-bank-reserves-and-its-implications
The transition to an abundant reserve system occurred right after Kopits 1982-2007 reference period. Not only did Kopits insist on using a period of high inflation to forecast yield spreads in a period of expected low inflation, but also a period of scarce reserves to forecast yield spreads in a period of expected abundant reserves. There have been at least two structural changes in the determination in long-end rates between Kopits’s reference period and now.