Recession - 23.6% Chance Within Next Year

As of Wednesday’s close, the 10-year yield is at 2.69% and the 2-year yield is at 2.52%.

(Click on image to enlarge)

It’s possible the 11 basis point difference between the 10 and 2-year in December was the bottom instead of an inversion being the bottom. 

We’d need to see much more than the 6 basis points of steepening to conclude this. Whether the curve is starting to steepen or is still flattening affects the business cycle’s timeline.

If the curve were to steepen sharply, a recession would be afoot in the next 6 months. 

Recession - If the curve is still flattening, a recession is over 1 year away. 

There are still 17 basis points left before an inversion. The curve can stay inverted for a few months. Then it will steepen. and a recession will soon follow. 

In looking at the economic data, I don’t see a recession occurring in 2019. Meaning, I’ll be looking for the 10-year 2-year curve to flatten in the next few months as I expect an inversion to occur in the first half of this year.

Recession Odds Increasing

NY Fed’s recession indicator uses the treasury spread to forecast the odds of a recession in the next 12 months. The chart below shows there’s a 23.6% chance of a recession by January 2020. 

In theory, I would agree with these odds because they are relatively low. However, this indicator isn’t like normal odds as only one previous recession had odds above 70%. Odds of about 40% almost guarantee a recession is coming soon. 

There even was a recession in 1960 where the odds didn’t get to 30%. The biggest false indicator this metric had was when the odds increased above 40% in 1967 even though there wasn’t a recession until 1970.

With this understanding, I don’t agree a recession is coming soon. The Fed is dovish, manufacturing is accelerating, and the consumer is strong. 

The consumer has deleveraged this cycle and is seeing real wage growth accelerate. Inflation has moderated. I don’t see an obvious reason for a recession in the near term. Oil prices have rebounded since December, which suggests oil won’t catalyze economic weakness like it did in 2015-2016. The banks are in much better shape than the last cycle. 

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