Yield-Curve Recession Indicator Flashes Yellow (Caroline Baum)

  Caroline Baum

  (Bloomberg) -- Sept. 5, 2006 -- Unless the shape of the Treasury yield curve normalizes in the next few months, going from its current negative to a more normal positive slope, the U.S. could be headed for a recession late next year.

  That's the implication of a new paper by economists Arturo Estrella and Mary R. Trubin of the Federal Reserve Bank of New York.

  Estrella has produced a significant body of research on the yield curve, or spread between a short- and long-term Treasury rate, as a predictor of recessions. One of his earlier co- authors, Columbia Business School professor Frederic Mishkin, will be sworn in today as a governor of the Federal Reserve Board.

  In ``The Yield Curve as a Leading Indicator: Some Practical Issues,'' which appears in the July/August issue of the New York Fed's ``Current Issues in Economics and Finance,'' Estrella and Trubin try to quantify yield-curve signals and provide ``practical guidelines'' -- rarely a priority in econometric research -- on interpreting the spread in real time.

  For ``maximum accuracy and predictive power,'' the authors use the average monthly spread between the Treasury 10-year constant maturity rate and the secondary market three-month Treasury bill rate expressed on a bond equivalent basis. ``All six recessions since 1968 were preceded by at least three negative monthly average observations in the 12 months before the start of the recession,'' they wrote.

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