The smoke signal is still burning: Is recession coming?
|Summary
In 2022, we released a three-report series to showcase useful tools for predicting recessions, the duration of recessions and monetary policy pivots. To quickly summarize, Part I dove into our Probit framework. Part II looked at historical trends with the 10-year/1-year Treasury yield spread. Part III incorporated the prediction power of the fed funds rate and the 10-year Treasury yield. This report presents updated results. In short, all of our tools are signaling a recession is more likely than not within the next year.
Probit Framework
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Our preferred Probit suggests there is a 55% chance of a recession during the next four quarters, based on data through February. Historically, whenever this Probit's probability has breached 50%, the U.S. economy experienced a recession within the next year.
10-year/1-year Treasury Yield Spread
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Last year, our preferred 10-year/1-year Treasury yield spread breached its recession-prediction threshold in August. The spread has remained negative since then, suggesting there is a 91% chance of a recession during the next 12 months. The inversion has steepened, averaging -118 bps in February, or the deepest monthly inversion since September 1981.
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Given the pattern of longer inversion durations matching up with deeper recessions, we believe that 12 consecutive months of a negative spread between the 10-year and 1-year Treasury yields is a solid benchmark to predict deeper-than-average recessions. With the 10-year/1-year spread negative for eight months straight, we suspect the likelihood of a deeper-than-average recession is rising.
Fed Funds Rate and 10-Year Treasury Yield
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The fed funds rate/10-year Treasury yield threshold breached back in March 2022, suggesting a recession and/or a Fed policy pivot is in the near-term picture. Since 1955, every time the fed funds rate has breached the 10-year Treasury yield's cycle low, a recession and accompanying change in monetary policy has occurred within the next 18 months.
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