Yield Curve Spreads

One of the many challenges facing investors is separating the signal from the noise, especially in an age with a thousands of data points (and increasing thanks to a growing collection of "big data"). Much of the data out there is highly volatile (what we call "stochastic") and of minimal value, if at all. One of the few data points that we find useful to keep tabs on is the 2s10s spread.


The above chart shows the 2s10s spread, which is the difference between the 2-year Treasury yield and the 10-year Treasury yield.


Above is a graph of the underlying 2-year and 10-year yields. The 2s10s spread (the first chart) is simply the red line minus the blue line.

The reason that I and many other investors (and economists too) reference the 2s10s spread is that it is a quick and simple indication of the slope of the yield curve, which is used to measure and estimate all sorts of things. Generally, the economy and markets tend to do well when the yield curve is steep and not so great when it is flattish or inverted (meaning the short-end of the yield curve is higher than the long-end).

The first chart shows the yield curve is rapidly flattening, which is of particular interest these days since the yield curve typically flattens and then inverts just before recessions (as indicated by the gray bars). This usually occurs because the 2-year yield rises much faster than the 10-year yield (as is happening now) and eventually surpasses it. The yield curve is not inverted yet and rapid flattening often coincides with tremendous economic and market performance; it does not appear that the curve will invert for at least 6-12 months (if it does at all), so no need to panic yet.

It is worth mentioning that some of the smartest asset managers out there think that the yield curve conveys less information now than in the past, due to a variety of reasons that I won’t get into here. Those managers may very well be right, but the 2s10s spread has a much better recession-calling record than anyone I know of. Further, past episodes of yield curve flattenings and inversions were “explained” as benign signs by the top minds during those respective times. Of course, we do not need to constrained to only using 2-year and 10-year spreads, as it is illuminating to look at the entire Treasury yield curve as well. One way to look at it is below:

Treasury Yields Over Time.png

Treasury yield spreads are just a few of many data points and we're neither supporting nor denying their significance. It is something that many people watch and we believe it bears watching as well.