Recession Odds at 92% Ahead of Powell Speeches

US treasury yields inched higher over the past week with Friday’s US Services PMI surprising to the upside through February. There was a sizeable jump in the employment component, too, confirming resilient strength in the labour market. In Dominique’s eyes, the print confirms what other data prints have been showing: growth is rebounding.

This week, Dominique will wait and see if Chair Powell will submit to the pressure of another 50bp hike. He’s speaking twice, to the Senate (Tuesday) and House (Wednesday), before the pre-meeting blackout that starts on the weekend. So, if he intends to go for a 50bp hike at the 22 March meeting, he will very likely drop hints during the Q&A.

Turning to market moves, US 10Y yields closed the week at 3.97% (+2bps WoW) compared to 4.86% (+8bps WoW) for the 2Y and 4.74% (+2bps WoW) for the 3M. The magnitude of the 2s10s inversion deepened to -89bps. The magnitude of the 3M10Y inversion increased to -77bps. The probability of recession increases with yield curve inversion.

Our recession model, which uses the 2Y10Y part of the yield curve, assigns an 92% chance of a recession within the next twelve months (Charts 1 and 3). Meanwhile, the Fed recession model, which uses the 3M10Y part of the yield curve, produces a 45% 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.

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. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.

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.

Photo Credit: depositphotos.com

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