The difference between US 10-year and 2-year yields has fallen to around 45 basis points. That is a flattening of the US yield curve of almost a full percentage point in the last four months. It raises the question of whether a new recession is imminent.
The US 10-year-2-year yield curve has accurately predicted the previous six recessions. This always happened when the yield curve turned negative. When the yield curve is positive, its predictive power with regard to future economic growth is significantly less impressive. As the yield curve is currently still positive, we cannot say with much certainty that a recession is imminent.
In addition, the other top indicator, the 10-year-3-month yield curve has not flattened at all. On the contrary, it has steepened further, reflecting the fact that markets expect the Fed to intervene heavily to restore its credibility as an inflation fighter. The 10-year-3-month yield curve does not point to a recession.
Other recession indicators
Although the above yield curves have the best track record as a recession indicator, there are more indicators that say something about the likelihood of a recession. The table below shows that even based on these indicators a recession is not immediately imminent.
Nevertheless, recent developments in these indicators suggest that the likelihood of a recession is increasing. In the case of US consumer confidence, the probability of a recession is even high. Confidence measured by the University of Michigan has fallen to its lowest level since October 2011. Incidentally, the confidence figure from the Conference Board, the University of Michigan’s competitor, has yet to be published for January.
Growth sacrifice
The decline in US consumer confidence reflects the risk that I am wrong about not having to expect a recession in the short term. With 7.5 percent inflation on the table and interest rates still extremely low, there may be uncertainty whether prices will come down substantially anyway. That forces the Fed to sacrifice either growth or equity markets, or both, to keep inflation in check. Judging by the 10-year-2-year yield curve, growth certainly seems to be part of the sacrifice.