Economics & Growth | Monetary Policy & Inflation | US
Recession Probability Remains Within 40-50% Range
- By Dalvir Mandara and Bilal Hafeez
- 2 min read
The yield on the 10y hit two-week highs of around 2.96% on Friday – that’s up 20bps over the past seven days. Short-term yields are also rising, though at a slower rate than that of the 10y – they are currently around 2.66%, up 16pp over the past seven days. That shorter-term yields are rising slower than longer-term yields has caused an increase in the slope of the 2s10s curve, which mechanically reduces the probability of a recession.
Our recession model that uses the 2s10s curve as input is now assigning a 43% chance of recession within the next twelve months – down 2pp from last week (Chart 1). Notably, the recession probability has been in a range between 40% and 50% since 10 May. 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).
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).
