Recession Probability Hits 90% Again

May nonfarm payrolls (NFP) supported both hawks and doves. The May NFP release (339,000 vs 195,000 expected) showed a combination of high employment growth, low unemployment, and no nominal wage acceleration. Should this pattern persist, it could provide the Federal Reserve (Fed) with further cover to delay rate hikes.

We no longer expect a hike in June following VC nominee Jefferson’s dovish comments but see a good chance of a hike in July based on a positive outlook on growth and inflation.

Turning to market moves, US 10Y yields closed the week at 3.69% (-14bps WoW, +25bps MoM) while the yield on the policy-sensitive US 2Y closed the week at 4.50% (flat WoW, +53bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -81bps on Friday. The probability of recession increases with yield curve inversion.

The probability of recession within the next twelve months, assigned by our recession model, which uses the 2Y10Y part of the yield curve, oscillated between 88% and 90% throughout last week, before closing the week at 90%. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produced a 70% 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. 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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