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Central banks around the world stepped up rate hikes last week. The Fed hiked by 75bps, as expected. Elsewhere, Riksbank (Sweden) hiked by 100bps, The Swiss National Bank hiked by 75bps, The Bank of England hiked 50bp (also as expected) as did Norges Bank (Norway). Markets are now pricing in an additional 125bps hikes from the Fed by end-2022. Accordingly, US 10Y yields rose to 3.69% on Friday – their highest level in 10 years. The yield on the 2Y also continues to soar – its currently at 15-year highs (4.3%). 2Y yields are up almost 100bps over the past month and the inversion in 2s10s has broken down through -50bps. The probability of recession increases with yield curve inversion.
Our recession model, which uses the 2Y10Y part of the yield curve, now assigns an 82% chance of a recession within the next twelve months (Charts 1 and 3). Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produces a 15% chance of recession (Chart 2).
Background to Models
We introduced two models for predicting US recessions using the slope of the US 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. Our model is based on the 2s10s curve compared to a model from the Fed that is based on the 3M10Y curve. We believe that the 2Y better captures expectations for Fed hikes in coming years and is, therefore, more forward-looking.
Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
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