Recession Probability Stays Elevated After Latest Fed Minutes

US treasury yields continued to rise last week as investors digested minutes from the most recent FOMC meeting, which pointed to the possibility of further interest rate hikes. Notably, the Federal Reserve (Fed) remains concerned about the pace of inflation, ‘with inflation still well above the Committee’s longer-run goal and the labour market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy.’

Turning to market moves, US 10Y yields closed the week at 4.26% (+10bps WoW, +51bps MoM) while the yield on the policy-sensitive US 2Y closed the week at 4.92% (+3bps WoW, +18bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -66bps 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 56% 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.

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.

Photo Credit: depositphotos.com

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