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What do other term spreads do? What does the U.S. spread mean for foreign economic activity?


as stated in the post Rashad Ahmed, developments in foreign yield curves help predict U.S. growth. What do these spreads do? And, turning the question around, what do U.S. interest rate differentials mean for recession prospects in these economies?

Figure 1 plots the 10-year to 3-million sovereign yield over time – thus before the 2007 recession and on the eve of the 2020 pandemic.

figure 1: 10 Year to 3 Month Treasury Spread (Bold Black), 10 Year to 3 Month Government Bond – Canada (Blue), France (Brown), Germany (Green), Japan (Red), UK (Dark Grey) 3-month interbank spread. Source: Treasury via FRED, OECD key economic indicators via FRED, and author’s calculations.

A cleaner measure for foreign countries would be to use sovereign yields on short-term rates to match U.S. spreads (and control for default risk), but I can’t do that lightly.

although Chin and Cook (2015) Examining our own cross-country evidence that 10-year to 3-month term spreads predict recessions, we do not examine whether US term spreads have predictive power for foreign recessions. Flour (2009) The usefulness of U.S. interest rate spreads in predicting economic activity and inflation rates in other countries is studied – but using 5-year to 3-month spreads. See this issue of “A (brief) review of forecast recessions across countries” postal.

A quick and dirty look at the data shows that US term spreads do not do much to increase the predictive power of the 12-month own term spreads for the aforementioned countries in recession from 1970-2022M05 (recession peak to ECRI trough dates) . The probabilistic regression involves the local recession indicator on the LHS, and the local term spread on the RHS, alone and increasing with the US term spread, and a constant. (Of course, the results may change with the addition of other covariates, such as oil prices, stock prices, and some measures of financial well-being).

Note that I only checked for recession; I did not check for growth or inflation. talk about it later.



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