US treasury yields rose last week after multiple economic indicators signalled persistent inflationary pressures, a tight labour market, and strong growth.
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US treasury yields rose last week after multiple economic indicators signalled persistent inflationary pressures, a tight labour market, and strong growth. This included initial weekly jobless claims coming in below expectations and the ISM Services index for August (54.5) surpassing expectations (52.5) – a reading over 50 indicates growth in the services industry. Meanwhile, the Atlanta Fed nowcast of Q3 GDP rose to 5.8% from 5.6% a week ago and compared with trend of 2%. Dominique believes growth is likely to continue surprising on the upside which will lead the Federal Reserve (Fed) to reduce the number of 2024 cuts in this month’s SEP and hike in November 2023.
Turning to market moves, US 10Y yields closed the week at 4.26% (+17bps WoW, +24bps MoM) while the yield on the policy-sensitive US 2Y closed the week at 4.98% (+13bps WoW, +24bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -72bps on Friday, up from year lows of -109bps seen in early July. 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, closed the week at 88% (Chart 1). Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produced a 57% 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.