Terms

Yield Spreads

Nick Name
Yiled Curve
Yield Spreads measure the difference in interest rates at a given time for debts of various maturity dates but the same quality


  • The most common spread looked at is the US 10 Year Treasury Bond minus the US 3 Month Bill
  • Typically look at long-term rates vs. short-term rates
    • Long term rates usually are higher than short term rates
  • Example:
  • Falling US Treasury Yield spreads may help indicate an upcoming recession
    • This erodes the profitably of banks
    • Erodes the profitability of anyone borrowing short & lending long
  • Studied by the San Francisco Federal Reserve
  • Ten Year minus Three Month yield spread is "the most reliable" indicator of a recession in the next 12 months (compared to other spreads)
    • All historical inversions have been followed by recessions
    • A negative spread is not required.  Below a positive 40bp spread, historical recessions have occurred
    • 17/17 flattenings since 1921 have resulted in a recession
  • Falling yield spreads impact banks and other financial institutions that borrower short and lend long (reduced margins)


Flattening Yield Curve Impacts on Credit Quality

  • When yield curves flatten, lenders tend to lower their risk premiums to keep profits up
  • This setups up a bad situation (underwater loans)


Historical Examples Where the Fed Incorrectly Said Yield Spreads Don't matter