US Treasury yields rose on Friday as investors digested comments from several Federal Reserve (Fed) speakers and their implications for the next Fed rate hike on 1 February. Notably, speeches from Brainard (voter, dove) and Williams (voter, dove) implied support for a 25bp hike.
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US Treasury yields rose on Friday as investors digested comments from several Federal Reserve (Fed) speakers and their implications for the next Fed rate hike on 1 February. Notably, speeches from Brainard (voter, dove) and Williams (voter, dove) implied support for a 25bp hike. Considering FOMC participants’ comments, Dominique has changed her expectation to a 25bp hike at the 1 February FOMC meeting from 50bp, in line with expectations – though she still expects Q4 GDP (to be released on 26 January) to surprise on the upside.
Turning to market moves, US 10Y yields closed the week at 3.48% (+5bps WoW) compared to 4.14% (+2bps WoW) for the 2Y and 4.57% (+7bps WoW) for the 3M. The magnitude of the 2s10s inversion sits at -66bps while that of the 3M10Y part of the yield curve sits at -109bps. The probability of recession increases with yield curve inversion.
Our recession model, which uses the 2Y10Y part of the yield curve, assigns an 87% chance of a recession within the next twelve months (Charts 1 and 3). It has signalled, at least, an 86% chance of recession consistently since mid-November 2022. Meanwhile, the Fed recession model, which uses the 3M10Y part of the yield curve, produces a 58% chance of recession (Chart 2). Notably, both models are producing recession probabilities higher than that of the 2007-2008 Global Financial Crisis (GFC).
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 3M10Y curve. We believe that the 2Y better captures expectations for Fed hikes in coming years and is therefore more forward-looking.