Monetary Policy & Inflation | US
Banks went to unprecedented lengths to secure emergency liquidity. US banks borrowed a record $152.9bn from the Federal Reserve’s (Fed) discount window for the week ended 15 March…
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Banks went to unprecedented lengths to secure emergency liquidity. US banks borrowed a record $152.9bn from the Federal Reserve’s (Fed) discount window for the week ended 15 March, according to H.4.1 statistical release, published on Thursday. Furthermore, the Fed lent $11.9bn to US banks under the newly created Bank Term Funding Programme (BTFP).
Bond market volatility hit multi-year highs. Concerns about the health of the global banking system saw investors flock to safe-haven assets throughout the week. The policy-sensitive 2Y treasury yield had fallen 112bps WoW by Wednesday before closing the week at 3.81% (-79bps WoW). The last time US 2Y yields saw a WoW decline of more than 112bps was in October 1987 and the last time it declined more than 79bps WoW was in September 2001. Meanwhile, US 10Y yields closed the week at 3.39% (-31bps WoW).
Will the Fed Hike this week? Dominique expects the Fed will pause this week to balance concerns around its ability to implement its inflation mandate independent of the current financial instability while trying to maintain the confidence of market participants. If they do pause, the Fed is likely to stress that it will be transitory.
Recession probabilities dropped. The probability of recession within the next twelve months assigned by our recession model, which uses the 2Y10Y part of the yield curve, fell to 78% (previously 92%) on Friday. Meanwhile, the Fed recession model, which uses the 3M10Y part of the yield curve, produces a 54% chance of recession (Chart 2). Notably, both models are producing recession probabilities higher than that of the 2007-2008 Global Financial Crisis.
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.