Yield Curve Based Recession Indicators Remain Elevated After Mixed Data

US treasury yields rose last week after mixed data:

• Wednesday’s March CPI data showed no incremental progress on disinflation, despite the headline figure (+0.1% MoM) rising less than expected (+0.2%). Notably, a smaller decrease in used car prices offset a slower increase in shelter costs.
• On Thursday, March Producer Price Index (PPI) revealed a decline to +2.7% YoY, below expectations of +3.0%.
• Headline retail sales on Friday fell more than expected, though the control group painted a different picture (-0.3% vs –0.5% expected) while US consumer sentiment (63.5) came in higher than expected (62.0) after the University of Michigan’s preliminary April report. Additionally, year-ahead inflation expectations rose from +3.6% in March to +4.6% in April.

Turning to market moves, US 10Y yields closed the week at 3.52% (+13bps WoW, +1bp MoM) while the yield on the policy sensitive US 2Y closed the week at 4.08% (+11bps WoW, +15bps MoM). In terms of yield curve inversion, the magnitude of the 2s10s inversion sat at -56bps on Friday. 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, fluctuated between 81% and 85% throughout last week, before closing the week at 83% Friday. Meanwhile, the Fed recession model, which uses the 3M10Y part of the yield curve, produced a 68% 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.

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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