Interest Rate Spread

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The following is excerpted from a press release by the Conference Board, a private organization that compiles The Index Of Leading Economic Indicators. Interest Rate Spread is one of the components of the Index. The press release is dated August 21, 2003:

"The Conference Board announced today that the U.S. leading index increased 0.4 percent, the coincident index increased 0.1 percent, and the lagging index increased 0.1 percent in July. The leading index increased for the fourth consecutive month in July. The leading index has now increased significantly (almost 2 percent) from its recent low in March, and this growth has been widespread. The coincident index increased slightly in July. The coincident index has now been rising gradually from its recent low in April, with increases in personal income, industrial production, and manufacturing and trade sales partially offset by continued declines in employment. The recent improvement in the growth rate of the leading index is similar to its performance at the end of 2001 and in early 2002, which was followed by stronger economic growth. The leading index is again signaling a pickup in the rate of economic growth, which is starting to be reflected in both real GDP and the coincident index. LEADING INDICATORS. Half of the ten indicators that make up the leading index increased in July. The positive contributors - beginning with the largest positive contributor - were interest rate spread, real money supply, average weekly initial claims for unemployment insurance (inverted), vendor performance, and stock prices. The negative contributors - beginning with the largest negative contributor - were average weekly manufacturing hours, index of consumer expectations, building permits, manufacturers' new orders for nondefense capital goods, and manufacturers' new orders for consumer goods and materials. The leading index now stands at 112.5 (1996=100). Based on revised data, this index increased 0.3 percent in June and 1.1 percent in May. During the six-month span through July, the leading index increased 1.2 percent, with six of the ten components advancing."

http://www.globalindicators.org/us/LatestReleases/

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The following perspective is excerpted from a speech given by Federal Reserve Governor Mark W. Olson at The Economic Growth And Regulatory Paperwork Reduction Act Of 1996 Outreach Meeting held in St. Louis, Missouri on June 26, 2003. In it he discusses the challenges for banks to make profits in a low-interest rate environment, as well as the difficulties experienced by the Fed in balancing this with the needs of depositors:

"Through a surge in core deposits, today's low interest rates have given banks an unusual opportunity to regain deposits lost during the past decade to money market funds and other investments, without the need for massive investment in bricks and mortar. Through judicious management, banks may be able to retain some portion of these gains beyond this period of low interest rates.

Now that I have discussed the management challenges posed to bankers by low interest rates, I should note that this environment also affects their customers. Some, such as mortgage borrowers, obviously have benefited. For others, namely depositors on a fixed income, low rates are a challenge. We at the Federal Reserve do assess the impact that changes in interest rates can have on particular segments of the economy, both advantageous and disadvantageous, and we are, of course, aware that people on fixed incomes can be adversely affected as rates decline. The goals of monetary policy, however, are to foster conditions conducive over time to maintaining low and stable inflation and maximum sustainable economic growth. As policymakers, we must make decisions that provide the greatest benefit to the economy overall. When the economy is weak, for example, increasing rates would likely result in further weakness, a result that would not be in our nation's best interest."

http://www.federalreserve.gov/boarddocs/speeches/2003/20030626/default.htm

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The following quote comes from an article written by Michael Dotsey in the summer 1998 issue of the Federal Reserve Bank of Richmond Economic Quarterly, entitled "The Predictive Content of the Interest Rate Term Spread for Future Economic Growth". In it he reviews some of the recent economic literature on the interest rate spread (also known as the yield spread or yield curve):

"Estrella and Mishkin (1998), for example, using data over the period 1959:1 to 1995:1, show that the spread between the yield on the ten-year and three-month Treasury securities is the best out-of-sample predictor of the probability of a recession occurring in the next four quarters. For shorter horizons, they find that adding movements in various stock price indexes improves forecast accuracy. Dueker (1997) also finds that the yield spread is a relatively good in-sample predictor of recessions. He adds a lagged-state-of-the-economy variable and finds that it helps his model predict the severity and duration of big recessions; but as in other studies, he finds that milder recessions are harder to predict."

Dueker, Michael J. "Strengthening the Case for the Yield Curve as a Predictor of U.S. Recessions," Federal Reserve Bank of St. Louis Review, vol. 79 (March/April 1997), pp. 41-51.

Estrella, Arturo, and Frederic S. Mishkin. "Predicting U.S. Recessions: Financial Variables as Leading Indicators," Review of Economics and Statistics, vol. 80 (February 1998), pp. 45-61.

http://www.rich.frb.org/eq/pdfs/summer1998/dotsey.pdf