Term Spread

Related to Yield Curve Control

The "term spread" aka "yield curve" is the difference in the *interest rates* of long-term and short-term government bonds

E.g. the "3-year/5-year term spread" is the effective yield for government bonds that mature 5 years from now *minus* the effective yield for government bonds that mature 3 years from now

Today (1/19/2026) those values are 3.82% and 3.66% respectively according to https://www.cnbc.com/quotes/US5Y and https://www.cnbc.com/quotes/US3Y. Which means the term spread is 0.16%, or 16 basis points.

According to Google AI overview: "A positive term spread means long-term interest rates are higher than short-term rates, signaling a healthy, growing economy (normal yield curve); a negative term spread (inverted curve) means short-term rates exceed long-term rates, often predicting an economic slowdown or recession"

Derivation of Treasury Bond Price contains equations, analyzed below, that tell us how this curve is impacted by market demand:

If a recession is predicted i.e. there's a negative term spread and inverted yield curve, either one of the two is happening:

A) The effective yield, "r", of short-term bonds have gone up. Since r = (FV / PV) - 1 and FV is constant (the bond payout at maturity can't change), this means that the *price* of short-term bonds have *decreased*. This is because effective yield, "r", and bond price, "PV" have an inverse relationship. This means the demand for short-term bonds have shrunk.

B) If not, then the effective yield, "r", of long-term bonds have gone down. This means, from r = (FV / PV) - 1, that the price for long-term bonds have gone up, reflecting higher market demand for long-term bonds

A negative term spread can also be a combination of both of the above factors A and B.

An AI research paper titled Term Spread Prediction Using LASSO in Machine Learning Frameworks reveals that American Industrial Production is MOST HIGHLY NEGATIVELY CORRELATED (relative to other indicators) with the Treasury bond term spread, meaning that UNUSUALLY STRONG INDUSTRIAL PRODUCTION INCREASES CHANCES OF RECESSION, according to the logic of the bond market.

Industrial production has effectively flatlined in America over the past 16 years, meaning the US has been able to avoid a second GFC by neutering its industrial production: https://fred.stlouisfed.org/series/IPFPNSS