Downturns and changes in the yield slope

We show that the slope of the sovereign yield curve predicts future economicactivity not only through its level but also through its changes (or differences)over time. Our results with US data show that the additional inclusion of thechanges of the yield slope in the traditional regressions significantly increasesthe explanatory power of the yield curve. Through the yield slope decomposi-tion, we find that positive changes in both the risk-neutral spread and the termpremium increase the likelihood of recession in the next 3 or 12 months. Esti-mated linear equations that directly forecast economic activity confirm the pre-dictive power of both components in the medium run. These predictiveequations also identify the term premium as the relevant component of yieldslope changes for medium-run (3–12 months) forecasts. Our out-of-sample exer-cises show that the empirical models including both the level and the differencesof the slope perform better than the models including only the yield slope level.