Recession on the Horizon?

Posted on March 18, 2016 by Admin

Due in part to recent stock market volatility, fears of another recession have been growing. This despite a relatively healthy U.S. labor market and few indications that the economy is slowing with the exception of weakness in the manufacturing sector.

Nobel laureate Paul Samuelson famously said, “The stock market has called nine of the last five recessions.” That is, stock market declines often give us false positives.

The yield curve is one of the few predictors of recessions which does not send out false positives. An inverted yield curve (i.e., when short-term interest rates are higher than long-term interest rates) has preceded each of the last seven recessions.

The chart below shows the difference in basis points (i.e., one hundredth of a percentage point) between the yield on the 10-Year Treasury and the 3-Month Treasury going back to 1987. The spread turned negative before all three recessions over this period. Currently, the yield spread is 163 basis points.

Treasury Yield Spread: 10-Year Bond and 3-Month Bill (in basis points) Treasury Yield Spread: 10-Year Bond and 3-Month Bill (in basis points)

Chmura’s recession model uses the yield spread among other variables to forecast the probability of recession in the next six months. Based on January 2016 data, the model estimated the probability of recession at 10%, up from just 1% in December 2015; the increase was mainly due to the drop in the stock market. According to the most recent February data, the probability of recession is 6% through August 2016—suggesting the U.S economy will continue to expand.

Probability of Recession Index Probability of Recession Index

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This blog reflects Chmura staff assessments and opinions with the information available at the time the blog was written.