Recession Probability Dips on Prospect of Easing Rate Hikes

US Treasury yields dipped on Friday as Nick Timiraos suggested the Federal Reserve (Fed) could slow the pace of hikes at the December FOMC meeting. Dominique continues to expect 75bp hikes in November and December.

Turning to market moves, the 10Y yield reached 4.2% on Friday (+92bps MoM), it was as high as 4.24% (its highest since 2010) the day before. Similarly, the yield on the 2Y hit 4.62% on Thursday – a level not seen since 2008 – before it closed the week around 4.5% (+101bps MoM). Increases in 2Y yields have continued to outpace that of the 10Y, though the difference in MoM increases between the two has narrowed. Consequently, the inversion of the 2s10s curve moved to –28bps, from -48bps in our last report, to -28bps. Mechanically, this reduced the probability of a recession.

Our recession model, which uses the 2Y10Y part of the yield curve, now assigns an 73% chance of a recession within the next twelve months (Charts 1 and 3). It has been signalling at least a 70% chance of recession consistently since 13 September. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produces a 20% chance of recession (Chart 2). The probability of recession increases with yield curve inversion.

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.

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