Estimated Probability Of Recession In August 2020 = 49%

The estimated probability of recession in August 2020 is 49% … using plain vanilla 10yr-3mo probit regression, over 1986M01-2019M08 period, using data shown below in Figure 1.

(Click on image to enlarge)

Figure 1: Treasury 10yr-3mo spread (blue) in %. NBER defined recession dates shaded gray. Source: Federal Reserve via FRED, Treasury, NBER, and author’s calculations.

As noted in this post, based on the first half of August, the probability of a recession in August 2020 was 47%. Using the entire August data, I obtain the following regression estimates:

Prob(recessiont+12) = -0.329 – 0.869 spreadt + ut+12

McFadden R2 = 0.29, NObs = 392. Coefficients significant at 5% msl bold. The spread is in percentage points.

Here are the predicted probabilities:

(Click on image to enlarge)

Figure 2: 12 month ahead probability from probit regression on 10yr-3mo spread, (teal). NBER defined recession dates shaded gray. Forecast period shaded light green. Source. NBER and author’s calculations.

Should one deliver a recession call? That would depend on the threshold. Over the last three recessions, a 40% threshold would catch all three recessions, and yield no false positives. 49% > 40%.

Obviously, if one believes this time is different — so one should use a term premium adjusted spread — the implied probability of recession would be lower (as demonstrated in this post).