After Fed Hike, US Recession Risks Now At 50%

The Fed started its hiking cycle last week with a 25bps increase in policy rates. This saw the US yield curve (2s10s) flatten even further. Our recession model that uses this curve as the input is now assigning a 50% probability of recession within the next twelve months. The last time we saw this probability was in the first quarter of 2020. Meanwhile, the Fed’s recession model which uses the 3m10y part of the yield curve is still only assigning a 3% probability of recession. With the recent energy price shock, we are definitely more in the recession risk camp.

Background to Models

We introduced two models for predicting US recessions using the slope of the 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. One model from the Fed is based on the 3m10y curve and the second is our modified version based on the 2y10y curve. The two-year would better capture expectations for Fed hikes in coming years. It is therefore more forward-looking. So, our preferred yield curve is the 2y10y curve (10-year yields minus two-year yields).

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.

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. 

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