Monetary Policy & Inflation | US
Recession Odds Rise After Hot PCE Print
- By Dalvir Mandara and Bilal Hafeez
- 2 min read
US treasury yields moved sideways for most of the past week. Then, on Friday, US PCE (headline: +0.6% MoM vs +0.5% MoM exp.; core: +0.6% MoM vs +0.4% MoM exp.) proved hotter-than-expected, accelerating across most categories of goods and services.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
US treasury yields moved sideways for most of the past week. Then, on Friday, US PCE (headline: +0.6% MoM vs +0.5% MoM exp.; core: +0.6% MoM vs +0.4% MoM exp.) proved hotter-than-expected, accelerating across most categories of goods and services. Moreover, a strong acceleration in January real income and spending points at accelerating growth momentum. US bonds sold off following the release.
However, Dominique warns that, because of the Federal Reserve’s (Fed) stance, it is unlikely to impact the outcome of the next FOMC meeting. Looking forward, it is the February NFP (10 March) that is likely to be a more important determinant of the Fed’s aggressiveness. As it stands, markets are pricing c.30bps for the next two meetings, and close to 75bp more of hikes.
Turning to market moves, US 10Y yields closed the week at 3.94% (+12bps WoW) compared to 4.81% (+21bps WoW) for the 2Y and 4.78% (+0bps WoW) for the 3M. The magnitude of the 2s10s inversion deepened to -88bps. The magnitude of the 3M10Y inversion is -89bps. The probability of recession increases with yield curve inversion.
Our recession model, which uses the 2Y10Y part of the yield curve, assigns an 90% 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 50% 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.
