Economics & Growth | Monetary Policy & Inflation | US
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US 10y treasury yields touched 3% for the first time since 2018 on Monday as investors prepare for a 50bps hike at Wednesdays Fed meeting. Short-term yields are moving up too with US 2y yields jumping 5bps over the past week compared to the 10y’s 9bps increase. In the short term, the faster increase in the 10y yields compared to that of the 2y has increased the slope of the 2s10s curve which mechanically reduces the probability of a recession. These moves have led our recession model to assign a 45% chance of recession in the next twelve months. This probability has been oscillating in a range between 40% and 60% since 3 March. Meanwhile, the Fed’s recession model, which uses the 3m10y part of the yield curve, continues to give only a 2% probability of recession.
Background to Models
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).