Recession Odds Tick Higher as Fed Steps Up the Pace
(2 min read)
(2 min read)
A WSJ article, that suggested a 75bps hike from the Fed was coming, pushed US yields to a top on Tuesday, a day prior to the FOMC meeting (Dominique’s FOMC Review). The US 2Y treasury peaked just shy of 3.45% last Tuesday, with the 10Y peaking just above 3.5%. The 2s10s slope briefly inverted at that time. Following last Wednesday’s Fed, it steepened up to 15bp before flattening off into the week’s close, a net flattening of 4bps since the end of the week prior.
The 2s10s flattening sent our recession model higher. It now assigns a 54.7% chance of recession within the next twelve months (Charts 1 and 3), slightly down from its intraweek high of 57%. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produces just a 3% chance of recession (Chart 2). This is in line with Loretta Mester’s recent comments that she is ‘not predicting a recession’.
We introduced two models for predicting US recessions using the slope of the yield curve. When long-term yields start to fall towards or below short-term yields, the curve flattens or inverts. This has often predicted a recession in subsequent months. One model from the Fed is based on the 3m10y curve and the second is our modified version based on the 2y10y curve. The two-year would better capture expectations for Fed hikes in coming years. It is therefore more forward-looking. So, our preferred yield curve is the 2y10y curve (10-year yields minus two-year yields).