Recession Probability Remains At 80%

April CPI showed no incremental progress on disinflation, despite Wednesday’s data showing that the headline figure rose slightly less than expected. A large increase in used car prices offset slower inflation in other categories, the ongoing recovery in rental indices suggests that progress on shelter cost inflation may be transitory, and April core goods inflation rose to +0.6% MoM due to a 4.4% increase in used car prices. US treasury yields tumbled on the news with US 10Y yields closing the day -10bps from the day prior.

April US producer prices rose at their slowest pace since January 2021, according to data released by the BLS on Thursday. US treasury yields fell further on the news, albeit smaller in magnitude compared to their response to April CPI.

Markets appear to be pricing in an easing of inflationary pressures with the latest 30-Day Fed Funds futures pricing implying just a 12% chance of a hike in June. We disagree, the labour market remains very tight, and inflation is still well above target. A continuation of these dynamics (barring a debt ceiling crisis) would make a 25bp hike in June likely.

Turning to market moves, US 10Y yields closed the week at 3.46% (+2bps WoW, +5bps MoM) while the yield on the policy-sensitive US 2Y closed the week at 3.98% (+6bps WoW, +3bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -52bps 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 in a tight range between 80% and 82% throughout last week, before closing the week at 82% Friday. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produced a 72% chance of recession (Chart 2). Notably, both models are producing recession probabilities higher than that of the 2007-2008 Global Financial Crisis.

Background to ModelsWe 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.

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