Economic Forecasting in Canada using the Near-Term Forward Spread

Abstract

The slope of the term structure of interest rates has been shown to provide useful information about future economic conditions. Measures of yield spreads between long-term and short-term securities have demonstrated the ability to forecast macroeconomic variables such as output, inflation, consumption, industrial production, and future recessions. This paper extends the work of Engstrom and Sharpe (2019) to test the predictive power of the near-term forward spread for recessions, real GDP growth and inflation in Canada. In contrast to conventional long-term spreads, this novel measure developed by the authors of the study is a yield spread of a shorter time horizon that provides an alternative measure of market expectations of near-term monetary policy rates. My results show that the near-term forward spread does a better job of forecasting future Canadian recessions than two of the most commonly used yield spreads, the ten-year minus the two-year yield spread and the ten-year minus the three-month yield spread. Furthermore, the near-term forward spread is useful for forecasting real GDP growth, but does not provide any useful information about future inflation in Canada.