March 24, 2023

GS “Recession Watch” Odds at 35%

From M. Abecasis/GS today:

Source: M. Abecasis, “Introducing Our Recession Watch Tracker,” U.S. Daily, Goldman Sachs, December 2, 2022.
I discovered it intriguing why, in part, they discount the estimates from standard term spread models:
When financial market participants see a higher probability of economic crisis, they are more most likely to expect the FOMC to cut the federal funds rate to stimulate the economy. We are hesitant that conventional yield curve designs will produce reasonable economic downturn chances in the present environment, as the Fed is likely to be more reluctant to alleviate policy for a provided set of growth and work results when inflation is high. While quantifying recession likelihoods based on historic experience is likely to produce misleading outcomes, the relationship between the policy rate and growth still makes market prices for the funds rate a helpful signal of expectations for the odds and timing of a potential recession. Currently, the bond market is pricing hikes through 2023Q2, however 42bp of cuts in 2023H2 (vs. 33bp at the end of October), 87bp of cuts in 2024H1 (vs. 50bp), and 57bp of cuts in 2024H2 (vs. 31bp).
Heres the picture of 10yr-3mo and 10yr-2yr term spreads as of close today:

Figure 2: 10 year-3 month Treasury term spread (blue), and 10 year-2 year spread (red), %. Source: United States Treasury, authors calculations.
Both spreads are now securely in unfavorable territory. My newest estimates (for data through Nov 23) here.

This entry was posted on December 2, 2022 by Menzie Chinn.

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