US treasury yields rose last week as markets digested the latest inflation data. Notably, August CPI (headline: +3.7% YoY vs +3.6% consensus) accelerated above expectations.
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US treasury yields rose last week as markets digested the latest inflation data. Notably, August CPI (headline: +3.7% YoY vs +3.6% consensus) accelerated above expectations. Core goods prices (excluding used cars) rose MoM, shelter inflation slowed but remained above levels consistent with the Fed’s target, and core services excluding housing inflation accelerated. Dominique believes markets are underestimating Federal Reserve (Fed) hikes and expects one more 2023 hike at the November meeting before a gradual resumption of hikes around mid-2024
Turning to market moves, US 10Y yields closed the week at 4.33% (+7bps WoW, +12bps MoM) while the yield on the policy-sensitive US 2Y closed the week at 5.02% (+4bps WoW, +10bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -69bps 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 87% (Chart 1). Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produced a 55% 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.