Keystone's 2-10 Spread Indicator

The 2-10 spread is a helpful indicator that quantifies the slope of the yield curve.  As the yield curve steepens, the banks and financials gain profits easier taking advantage of the greater differential.  As the yield curve flattens, or even inverts, this is a harbinger of troubled economic times ahead.  Typically, an inverted yield curve occurs about 12 to 18 months ahead of a recession or slow economic period.

A flat yield curve indicates weak growth, a steep curve indicates sharp growth.  At the equity market bottom in March-April 2009, the 2-10 spread was about 200 basis points.  By late 2009, the spread had increased to 290 points and the bankers were celebrating.  This steep yield curve continued into February 2010.  The equities top in April 2010 dampened the party and the 2-10 spread fell back to 270 in May 2010, and to a low of 200 in August 2010.  No doubt this is one of the factors that scared Chairman Bernanke in August 2010 and led to him announcing the QE2 POMO pump program to save the equities markets.

And the chairman accomplished his goal as the equities markets soared into 2011, with the 2-10 spread steadily climbing and hitting 290 in early 2011.  Some of the luster has come off the rose as the spread has fallen back down and is in danger of turning happy bankers into sad bankers.

As of today, 3/18/11, the 2-10 spread is 3.26%-0.58%=2.68%, or 268 basis points.

Keystone's key indicator is to watch the 255 basis point 2-10 spread area.  This is the line in the sand between happy bankers with steep yield curves, and sad bankers with flattening yield curves.  At 268 currently, well off the 290 highs, and only 13 points above Keystone's 255 threshold, the bankers remain happy, but, the party may be coming to a close.  As a projection, if the 10-year yield drops below 3.10% moving forward, then the 255 threshold will be close at hand, and this does not project well for the banks, financials, equities markets or overall economy.