Downturns and Changes in the Yield Slope

We show that the slope of the sovereign yield curve not only predicts future economic activity through its level but also through its changes. Our results with US data show that the inclusion of the first difference of the slope in the traditional yield slope regressions significantly increases the explanatory power of the yield curve. Decomposing the yield slope changes into those of the risk-neutral spread and of the term premium also brings insights into future economic activity forecast. We find that, while positive changes to the risk-neutral spread predict lower economic activity in the short-run (1-3 months), positive changes to the term premium predict lower economic activity in the medium run (3-12 months). These results are obtained at both monthly (industrial production, unemployment) and quarterly (GDP growth, unemployment) frequencies and also in probit-type recession regressions.