Monetary Policy & Inflation | US

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October CPI (headline: +0.4% MoM; core: +0.3% MoM) came in lower than expected (headline: +0.6% MoM; core: +0.4% MoM) causing treasury yields to plummet across the board (2Y: 4.34%, -37bps WoW; 10Y: 3.82%, -32bps WoW) and markets to par expectations for the Federal Reserve (Fed). However, Dominque believes the Fed still has a long way to go and continues to expect a 75bp hike in December and a terminal rate close to 8%.

Despite last week’s drop in yields, 2Y yields (+27bps MoM) continue to outpace 10Y yields (+10bps MoM) on a monthly basis. Consequently, the 2s10s inversion remains deeply negative at -52bps. We think it inverts to at least –100bps.

Our recession model, which uses the 2Y10Y part of the yield curve, now assigns an 82% chance of a recession within the next twelve months (Charts 1 and 3). It hit four-decade highs (84%) on 3 November and has signalled 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 34% 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.