Economics & Growth | Monetary Policy & Inflation | US
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US yields rose throughout much of H1. This trend has largely continued in 3M yields, but not so much in US 2Y and 10Y yields. Starting at a 3.5% peak in mid-June, 2Y yields have since retreated 56bps while 10Y yields have fallen 82bps. This has left the curve to flatten, with 2s10s inverting in early July. Turning to the past week, 2Y (-11bps WoW) and 10Y yields (-14bps WoW) have continued lower while 3M yields saw a near-term reversal of the recent rise (-21bps WoW). This is partly because the market thinks the Fed will give up on reaching its inflation target to avert a recession. We disagree. In fact, Dominique expects the Fed to hike another 175bps by end-2022.
Consequently, our recession model, which uses the 2Y10Y part of the yield curve, assigns a 70% 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, jumped to a 20% chance of recession (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 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.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)
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