The Yield Curve Steepens - Indicating That The Recession May Not Last A Year; But Does It Also Reflect A Bigger Bond Supply?

The Treasury yield curve continues to steepen and is now at its steepest in about three months. The steepening has both good and bad connotations to it. The most important positive is the message that a yield curve typically sends.

The current yield spread between three-month T-bills and 10-year T-notes -- the key empirical gauge -- is 276 basis points, a level that historically has indicated that the chances of recession 12 months hence are very small.

In a study by Estrella and Mishkin, a yield spread of more than 121 basis points was associated with just a 5% chance of recession, which makes the current level comforting. For reference, note that the same study showed that a yield spread of -82 basis points (an inverted yield curve), produced 50% odds of a recession. The yield spread was as wide as -60 basis points in February 2007.

Some of the recent steepening of the yield curve reflects the increase in Treasury supply, with the long end of the yield curve bearing the burden, the negative angle on the steepening. If the U.S. dollar were to fall, the steepening would take on an event larger negative angle, but any weakening would have to be significant to have meaningful impact on the yield curve on the whole.