Using alternative yield curves tells the same story of inversion - Recession coming

The yield curve is inverted. Who has not heard about? Who does not expect a coming slowdown given this information? Is there any more information that  needs to be said?  A Fed paper suggests that looking at the short-end of the curve may be slightly more informative than a 2-10 year Treasury spreads or some other Treasury combination like 10-year / 3-month spreads. (See "The Near-Term Forward Yield Spread as a Leading Indicator: A Less Distorted View" by Engstrom and Sharpe.) Now the yield curve inversion is somewhat of a blunt forecasting instrument. There can be variable lead times before a recession and it has predicted recession that did not occur; however, having alternative looks at the yield curve may provide additional information.

Engstrom and Sharpe find that the focus should be on the 12-18 month part of the forward curve. Their argument is that when the market prices in a monetary easing they are also pricing in an expected recession. The Fed is responding to the threat of a recession. 

Using their work with a simple variation, there is a lot to learn by focusing on shorter-term forwards as opposed to longer-term spreads. Here is the Eurodollar futures curve as forward yields out beyond five years. Notice the inversion that suggests a recession and is also consistent with easing monetary policy expectations. The real economy and monetary economy are closely linked. 

There is less noise from longer rates using the Eurodollar futures data. The long rate by definition is an average of expected short-rates so focusing on the 12-18 month curve is a more direct measure of changes in relative prices. While we still look at the consensus inversion numbers, we agree with the Fed researchers that short rates may provide better information.