YIELD CURVE

(FED Bank of New York 1997) Many types of prognostications are used to figure out where the economy is going to go. One method relates to the difference between ten year T-notes and three month T-bills. "Expectations of future inflation and real interest rates contained in the yield curve spread seem to play an important role in the prediction of economic activity." They offered the chart below with corresponding odds of a recession when the spread increased.

Estimated Recession Probabilities Four Quarters Ahead

Recession Probability	Value of Spread (Percentage Points)
5%	1.21
10	0.76
15	0.46
20	0.22
25	0.02
30	-0.17
40	-0.50
50	-0.82
60	-1.13
70	-1.46
80	-1.85
90	-2.40

It may be one of the great leading indicators for the current time since many others have not held up well at all.

Riding the Yield Curve: Diversification of Strategies  2004

Abstract: Riding the yield curve, the fixed-income strategy of purchasing a longer-dated security and selling before maturity, has long been a popular means to achieve excess returns compared to buying-and-holding, despite its implicit violations of market efficiency and the pure expectations hypothesis of the term structure. This paper looks at the historic excess returns of different strategies across three countries and proposes several statistical and macro-based trading rules which seem to enhance returns even more. While riding based on the Taylor Rule works well even for longer investment horizons, our empirical results indicate that, using expectations implied by Fed funds futures, excess returns can only be increased over short horizons. Furthermore, we demonstrate that duration-neutral strategies are superior to standard riding on a risk- adjusted basis. Overall, our evidence stands in contrast to the pure expectations hypothesis and points to the existence of risk premia which may be exploited consistently.

The Yield Curve as a Predictor of U.S. Recessions (2007) The yield curve—specifically, the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill—is a valuable forecasting tool. It is simple to use and significantly outperforms other financial and macroeconomic indicators in predicting recessions two to six quarters ahead.

Yield Curve article (Fed reserve 2007)

Daily Treasury Yield Curve Rates I said this back in 2000. When you have an inverted yield curve, you simply look for a significant slowdown in activity. Either long term rates rise or short term rates have to drop.

How Stable Is the Predictive Power of the Yield Curve?   (2007)Empirical research over the last decade has uncovered predictive relationships between the slope of the yield curve and subsequent real activity and inflation. Some of these relationships are highly significant, but their theoretical motivations suggest that they may not be stable over time. We use recent econometric techniques for break testing to examine whether the empirical relationships are in fact stable. We consider continuous models, which predict either economic growth or inflation, and binary models, which predict either recessions or inflationary pressure. In each case, we draw on evidence from Germany and the United States. Models that predict real activity are more stable than those that predict inflation, and binary models are more stable than continuous models. The model that predicts recessions is stable over our full sample period in both Germany and the United States.

That's why the problems in 2000 forward were- or should have been- evident. The inverted yield curve of that magnitude had identified 11 out of 12 of the past recessions. In the other case, the economic slowdown did happen but took longer.  

Since the 1970s, an inverted yield curve has been a reliable signal of an imminent recession. One interpretation of this signal is that markets expect monetary policy to ease as the Federal Reserve responds to an upcoming deterioration in economic conditions. Some have argued that the yield curve inversion in August 2006 did not signal an imminent recession, but instead was triggered by an unusually low level of the term premium. This article examines whether changes in the term premium can distort the recession signal given by an inverted yield curve. The authors use the Kim and Wright (2005) decomposition of the term spread into an expectations component and a term premium component to compare recession forecasting models with and without the term premium. They find that the expectations component of the term spread is a leading indicator of recession, while the term premium component is not. Their analysis of recession forecasting performance provides some evidence that a model based on the expectations component is more accurate than the standard model that uses the term spread.

Yield curve dissdertation: http://mises.org/etexts/cwik-dissertation.pdf    (2009)