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.