As shown in the chart below, each of the past six recessions (shaded areas)
was preceded by an inversion in the spread between the Treasury 10-year yield
and the fed funds rate. But there were two other instances of inversion - 1966:Q2
through 1967:1 and 1998:Q3 through 1998:Q4 - immediately after which no
recession occurred. It would appear, then, that an inverted yield curve is
more of a necessary condition for a recession to occur, but not a sufficient
condition. That is, if the spread goes from +25 basis points and to -25 basis
points, a recession is not automatically triggered. Rather, whether an inversion
results in a recession would seem to depend on the magnitude of the inversion
and, to a lesser extent, the duration of it. Recession-signaling aside, the
yield curve remains a reliable leading indicator of economic activity.
Although the spread going from +25 basis points to -25 basis points might not
result in a recession, it does indicate that monetary policy has become more
restrictive. For a description of the theoretical underpinnings of why the
yield spread is a leading indicator, see http://www.northerntrust.com/library/econ_research/weekly/us/pc070805.pdf.
For some descriptive data on the past eight spread inversions, see the table
below.

Table 1 - History of Spread Inversions
| Period of Inversion* |
Average
Spread
(b.p.) |
Maximum Negative
Spread
(b.p.) |
Minimum Negative
Spread
(b.p.) |
| 1966:Q2 - 1967:Q1 |
-30 |
56 |
13 |
| 1968:Q3 - 1970:Q2 |
-102 |
213 |
15 |
| 1973:Q2 - 1974:Q3 |
-295 |
413 |
101 |
| 1978:Q4 - 1980:Q2 |
-186 |
313 |
76 |
| 1980:Q4 - 1981:Q3 |
-326 |
361 |
273 |
| 1989:Q1 - 1989:Q4 |
-72 |
98 |
23 |
| 1998:Q3 - 1998:Q4 |
-26 |
33 |
19 |
| 2000:Q2 - 2001:Q1 |
-42 |
63 |
10 |
* Fed funds rate above 10-yr. Treasury yield