2s10s Spread
The yield curve — recession signal and FX direction simultaneously
- Define the 2s10s spread and what its shape signals
- Distinguish 'bull steepening' from 'bear flattening' and their FX implications
- Use curve shape as a leading indicator for FX regimes
The 2s10s spread (10y yield minus 2y yield) has correctly predicted every US recession in the last 50 years when it inverts. It also predicts FX regime shifts months before consensus. Reading curve shape is among the most powerful skills in macro.
Four curve shapes, four messages
Normal (positive spread): 10y > 2y. Growth expected; CB rate hikes priced in. Healthy expansion. Flat (spread ~0): market sees no growth advantage at long horizons. Late cycle. Inverted (negative spread): 2y > 10y. Markets expect future cuts; recession risk. Steep (large positive): post-recession recovery, CB cutting aggressively.
CB pivots dovish; cuts priced. Recovery phase. Currency typically WEAKENS as the rate differential narrows. AUD/USD usually rallies (risk-on).
CB hawkish; hikes priced. Late expansion. Currency STRENGTHENS as front-end yields rise. Classic late-cycle dollar bull pattern.
The four-way matrix in practice
Combine direction (steepen/flatten) with cause (which end is moving) and you have four distinct regimes: bull steepening (dovish), bull flattening (carry-friendly), bear steepening (inflation panic), bear flattening (hawkish CB tightening). Each has a textbook FX implication.
US 2s10s spread went from +50bp to -10bp over 3 months. Best read?
- 2s10s = 10y minus 2y yield
- Inversion historically signals recession 6-18 months out
- Bull steepening = dovish, currency weak
- Bear flattening = hawkish, currency strong
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