The Relation Between Default-Free Interest Rates and Expected Economic Growth Is Stronger Than You Think



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    • University of Washington. I thank Wayne Ferson, Campbell Harvey, Alan Hess, Vance Roley, Andy Siegel, René Stulz, the editor, Simon Wheatley, two anonymous referees, and seminar participants at the University of Washington for helpful comments. I thank the Chicago Mercantile Exchange and the Federal Reserve Bank of Kansas City, and in particular, Douglas Rolph, Norman Mains, Rob Neal, and Catherine Shalen for providing data.


The relation between default-free interest rates and expected economic growth is substantially stronger than suggested by extant literature. Futures-implied Treasury bill yield spreads are more highly correlated with future real consumption, investment, and GNP growth than spot spreads. This stronger relation arises because using futures removes a component of the spot term structure that covaries negatively with real economic growth. Treasury forward rates from spot bills contain a premium for the risk that short-sellers will default. This risk premium is negatively related to expected economic growth.