This visualisation shows the relationship between interest rate spreads and asset prices. An interest rate spread in plain English is the difference between long and short-duration bond yields. The two most popular interest rate spreads that are used by investors to determine the health of the economy are given below

a) The 10-Year Treasury Constant Maturity minus 2-Year Treasury Constant Maturity interest rate spread represents the difference between the yields on these two types of U.S. Treasury bonds. This spread is often used as an indicator of the yield curve slope or the term premium. The term premium is the excess yield that investors require to commit to holding a long-term bond instead of a series of shorter-term bonds. Hughely negative term premium indicates shortage of collateral.

A positive spread suggests that long-term interest rates (10-year) are higher than short-term rates (2-year), which is considered a normal or upward-sloping yield curve. This can imply expectations of economic growth and inflation in the future. It suggests that investors are demanding higher compensation for tying up their money in longer-term bonds.

Conversely, a negative spread, where short-term rates are higher than long-term rates, is known as an inverted yield curve. This can be a signal of economic uncertainty or expectations of future economic slowdown or recession.

b) The 10-Year Treasury Constant Maturity minus 3-Month Treasury Constant Maturity interest rate spread represents the difference between the yields on these two types of U.S. Treasury bonds. This spread is often used as an indicator of short-term interest rate expectations or market sentiment regarding monetary policy.

A positive spread suggests that long-term interest rates (10-year) are higher than short-term rates (3-month), indicating a normal yield curve. This can indicate expectations of economic growth and inflation.

On the other hand, a negative spread, where short-term rates are higher than long-term rates, could signal expectations of a future economic slowdown or tightening monetary policy by the central bank. In some cases, an inverted yield curve with a negative spread has been associated with upcoming recessions.

Other popular interest rate spreads can also be selected from the dropdown to draw inferences regarding the direction of the economy and the stock market.

Key Takeaways

An investor can monitor the interest rate spreads to determine their bets in the sectors and asset classes that benefit from an inverted, flat or upward-sloping yield curve. An inverted yield curve is a leading indicator that points to a potential upcoming recession. On the other hand the upward-sloping yield curve is a sign of health economy with future growth and inflation prospects.