Recession Probability Above 50% on Hot Inflation Print
(2 min read)
(2 min read)
The yield on the 2y breached 3% on Friday – it is up 40bps over the past seven days and is at its highest levels since 2008. The move came after inflation came in above expectations with May CPI at +8.6% vs +8.3% expected. Long-term yields are also rising – 10y yields are up 21bps over the past seven days. That short-term yields are rising faster than long-term yields has caused the 2s10s slope to flatten to almost 0. This mechanically increases the probability of a recession.
Our recession model that uses the 2s10s curve as input is now assigning a 54% chance of recession within the next twelve months – up 11pp from last week (Chart 1). Notably, this is the first time the recession probability has breached 50% since 6 April. Meanwhile, the Fed’s recession model, which uses the 3m10y part of the yield curve, still gives just a 3% probability of recession (Chart 2).
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).