The Inverted Yield Curve and the Components of GDP

Abstract

When 3-month Treasury rates are greater than 10 -year Treasury rates an inverted yield curve occurs. When this state is reached some argue that a recession is on the horizon, typically 6 months to a year down the road. Here, I reframe the question of whether inverted yield curves predict recessions in the US and ask what an inverted yield curve predicts. Using a Probit model I find that when 10-year US Treasury bonds yield less than 3-month US Treasury bills, a US recession, while probable, is not certain. Moreover, I find that indeed the strength of this indicator has weakened over the last 20 years. However, my findings do not suggest that an inverted yield curve provides no information about the future. In fact, I find that an inverted yield curve strongly predicts movements in the consumer durables and fixed private investment series of US GDP.