Philippine Markets Newsletter

PH Monday Macro: Yield curve is not an accurate indicator to predict Philippine recessions, unlike for the U.S.

March 13, 2023

In the U.S., the spread between the long versus short-term duration government bonds is used as a barometer to gauge what the credit market sentiment is. The difference between the two bonds is referred to as the “yield curve”. 

Historically, the yield curve predicted every U.S. recession. Though, does this apply to the Philippines?

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The yield curve results from taking the difference between short-term and long-term duration treasury bonds. Commonly, when we talk about the yield curve, it is the spread between the yields of 2-year and 10-year treasury securities.

Why is this used to forecast recessions?

The interest rate on treasuries represents the total return on investment that an investor will receive. When there is an increase in the bond yield, in theory, the value of such securities declines, and vice versa.

In the U.S., the interest rate on two-year treasury bonds has been increasing. This means there is less demand for such bonds. A reason for this is that there is short-term fear in the market due to recession concerns. Moreover, the market is also trying to price in another potential implementation of a rate hike by the Fed to combat inflation. 

Compared to the ten-year treasury, the interest rate has been on a downward trend because there is more demand for safe-haven bonds. If the market expects a recession, they are also anticipating the central bank to cut interest in accordance with its accommodative intervention policy.

This is why there is so much demand for the 10-year treasury – investors are locking in the current interest rate because they expect rates to be lower in the future. Expectations of low-interest rates lower the long-duration interest rates.

These treasury securities are sensitive to monetary policy as it reflects the overall market’s view of estimating the valuations of companies and economic expectation. To this, the two-year bond reflects the short-term view of the market, and the ten-year bond shows the long-term view of the market.

Since the bond market is influenced by the business cycle and monetary policy, taking the spread between the two-year and ten-year treasury is an attempt to gauge the sentiment and expectations of investors. Historically, in the U.S., if we put the spreads on a slope, a recession follows each time the yield curve inverts.

In the U.S. market, in the past 40 years, each time the spread difference hits negative territory, a recession follows. However, does this apply in the Philippines?

In the Philippine market, although the two-year and ten-year spreads historically did not predict a recession, let us see if it can estimate the country’s economic performance by comparing Philippine GDP quarterly growth and the 10-year & 2-year difference.

The yield curve relative to a monthly basis inverted only once during March 2019 when there were slowdown concerns due to global weakening demand and the trade war between the U.S. and China. In all periods, excluding March 2019, the difference between the fixed-income securities did not result in a negative figure.

Furthermore, it could be observed in the chart that the correlation level between spread fluctuations and the economic performance of the Philippines is weak. A reason for this is the foundational difference between the U.S. and the Philippine economy.

The U.S.’s most significant contributing industry to GDP is its finance, insurance, real estate, and leasing sector. These sub-industries growth is cyclical and depends heavily on interest rates. The spread difference leading indicator successfully predicts recessions because the largest industries to GDP are categorically sensitive to monetary policy.

On the flip side, in the Philippine economy, the service industry where BPOs (Business Process Outsourcing) and OFW remittances make up a sizable chunk of the economy. These industries are not interest rate sensitive. This is why the yield curve’s success in forecasting U.S. recessions does not apply to the Philippines. 

Nevertheless, it does not take away the fact that the yield curve is an excellent indicator of understanding how the market reacts to monetary policy and money and capital markets expectations.

About the Philippine Markets Newsletter
“The Monday Macro Report”

When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.

Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.

Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.

Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.

Hope you’ve found this week’s macro chart interesting and insightful.

Stay tuned for next week’s Monday Macro report!


Angelica Lim
Research Director
Philippine Markets Newsletter
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