Yield Curve Really Does Matter for Unemployment

By Tom McClellan

Yield Curve and Unemployment

Back in February 2007, former Fed Chairman Ben Bernanke actually said the following:

“I think the yield curve could be inverted for a considerable period without significant implications for the economy as a whole, yes— possibly for some banks, but not for the economy as a whole.”  He said that in testimony before the Senate Banking Committee.  To our knowledge, Dr. Bernanke has not been stripped of his degree in economics for that comment, as he rightfully should be.

This week’s chart is one which appeared in our most recent issue of The McClellan Market Report.  It highlights the very strong correlation (most of the time) between the Unemployment Rate and the yield spread between the 10-year and the 1-year T-Notes.  I say “usually” because the really extreme episode from 1978 to 1982 shows just how extreme that time period was.  The rest of the time, these two plots are usually pretty close to right on top of each other, given the scaling chosen for this chart.

Note also that every big up move in the Unemployment Rate over the past 60+ years has been preceded by a dip to a negative 10-1 yield spread.  Right now, the spread is getting dangerously close to inverting.  If the Fed could somehow manage the banking system in such a way as to forestall or even avoid such an inversion, then history shows that the Fed could postpone or fend off the next big damaging recession.

But wishing for that outcome is not greatly justified, based on either the Fed’s actual ability to make it happen, or the Fed members’ hubris in thinking that “it’s different this time”, and that they can manage things better than their predecessors.

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