Economics & Growth | Monetary Policy & Inflation | US
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The Fed raised rates 50bps at last week’s meeting – the biggest hike since 2000. US 10y yields have been soaring – they are currently around 3.15%, up 30bps over the past seven days. Short-term yields are moving up too, though not as fast as the 10y – US 2y yields jumped 14bps over the past week. A combination of the two has caused the slope of the 2s10s curve to rise, which mechanically reduces the probability of a recession.
Our recession model that uses the 2s10s curve as input is currently assigning a 37% chance of recession within the next twelve months – down 8pp from last week (Chart 1). Meanwhile, the Fed’s recession model, which uses the 3m10y part of the yield curve, now gives just a 1% probability of recession (Chart 2).
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).