2s10s Spread

A challenge (not unique) to investing is separating the signal from the noise. I find that the highly-stochastic nature of most data makes them practically useless (and thus noise). One of the few data points that I find useful to keep tabs on is the 2s10s spread.

The above chart shows the 2s10s spread, which is the difference between the 2-year Treasury yield and the 10-year Treasury yield.

Above is a graph of the underlying 2-year and 10-year yields. The 2s10s spread (the first chart) is simply the red line minus the blue line.

The reason that I and many other investors (and economists too) reference the 2s10s spread is that it is a quick and simple indication of the slope of the yield curve, which is used to measure and estimate all sorts of things. Generally, the economy and markets tend to do well when the yield curve is steep and not so great when it is flattish or inverted (meaning the short-end of the yield curve is higher than the long-end).

The first chart shows the yield curve is rapidly flattening, which is of particular interest these days since the yield curve typically flattens and then inverts just before recessions (as indicated by the gray bars). This usually occurs because the 2-year yield rises much faster than the 10-year yield (as is happening now) and eventually surpasses it. The yield curve is not inverted yet and rapid flattening often coincides with tremendous economic and market performance; it does not appear that the curve will invert for at least 6-12 months (if it does at all), so no need to panic yet.

It is worth mentioning that some of the smartest asset managers out there think that the yield curve conveys less information now than in the past, due to a variety of reasons that I won’t get into here. Those managers may very well be right, but the 2s10s spread has a much better recession-calling record than anyone I know of. Further, past episodes of yield curve flattenings and inversions were “explained” as benign signs by the top minds during those respective times. Not sayin’, just sayin’.

The 2s10s spread is just one of many data points and I’m neither supporting nor denying its significance. It is something that many people watch and I believe it bears watching as well.

***A six-month update can be found here: https://thoughtfulfinance.com/2018/07/18/yield-curve-inversions/

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Disclosures & Disclaimers page for a full disclaimer.

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