MH US Recession Odds Rise to Highest Since Dot-Com Bubble

US yields rose throughout much of H1, but since mid-June, there has been a growing dislocation between longer- and shorter-term yields. While 10Y UST yield has since pared by 72bps, 2Y UST yields have fallen just 20bps. This flattening became a 2s10s inversion in early July. Meanwhile, money market rates have continued to climb.

The past week, with its strong NFP numbers and hawkish Fed tone, has seen a bear-flattening in rates curves, with 2Y up 33bp and 10Y up 21bp. 3M yields bucked the trend. However, with the market currently pricing just 120bp to the end of the year, there is strong room for a further rise in money market yields ahead. Dominique expects the Fed to hike another 175bps by end-2022.

Consequently, our recession model, which uses the 2s10s part of the yield curve, now assigns a 77% chance of a recession within the next twelve months (Charts 1 and 3). This is its highest level since September 2000, just before the dot-com crash. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, pared slightly to 21% (down from intra-week highs of 24% (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.

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