Recession Odds Hit 75% Following Jackson Hole

Federal Reserve (Fed) members upped the ante last week. Not only was Chair Jerome Powell hawkish, Kansas City Fed President Esther George and Cleveland Fed President Loretta Mester noted interest rates could be held above 4% – higher than the current market implied terminal rate (3.85%). The impact on markets, however, was limited; the US 2s10s spread sits at -33bps.

On recession probabilities, our model, which uses the 2s10s part of the yield curve, assigns a 75% 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, remains close to 21% (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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