Recession Probability Rises on PCE Data

US Treasury yields had declined last week on Federal Reserve (Fed) pivot speculations, US 10Y yields dipped below 4% on Thursday. But Friday’s PCE data (+6.2%) confirmed inflation remained stubborn through September. Core PCE, which strips out food and energy components, rose to 5.1% YoY from 4.9% for August. Yields reacted accordingly – US 10Y yields climbed back over 4% and are up around 57bps MoM while US 2Y yields (4.4%, +54bps MoM) and US 3M yields (3.99%, +87bps MoM) followed suit. The inversion of the 2s10s curve deepened to –39bps from -28bps in our last report which mechanically increased the probability of a recession. The 3M10Y spread has flattened to just 3bps.

We expect a 75bp hike at the November 1-2 FOMC meeting. Dominique believes there will be no pivot announcement as it would ease financial conditions when inflation is still high and persistent.

Our recession model, which uses the 2Y10Y part of the yield curve, now assigns a 77% chance of a recession within the next twelve months (Charts 1 and 3). It has been signalling 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 27% 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.

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. 

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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