Recession probability - early warning system
Yield Curve Differentials
Credit Spread Differential
Recession Indicators
Insights
CONCEPT
Is a recession likely to happen soon? This dashboard is our forward-looking RADAR to answer the question. We scan for macroeconomic tail-risks using an early warning system monitoring structural shifts across: (1) US & EU Yield curve differentials (via US Treasury & German Bunds) and (2) US investment grade credit spread differentials (7-10Y minus 1-3Y) to spot early signs of market stress. We also track pure recession indicators such as (3) the Sahm rule (monitoring unemployment changes) plotted against the US NBER recession monitor, and (4) the NY Fed probability of recession based on US yield curve fluctuations.
CURRENT READINGS
- The German 10Y-3M curve is positive and normal, with later maturities paying more than shorter maturities. This indicator flags VERY LOW RISK of recession at the moment (toggle the chart to see comments on the US YC and/or German 10Y-2Y curve). In parallel, the US IG credit curve is flattening, indicating a MILD RISK of recession.
- The Sahm rule is at 0.2, falling and reporting a LOW RISK of recession. On the other side, The NY Fed recession model reports a 18.8% probability of recession probabilities 12-months from now (LOW RISK). In summary, a recession is unlikely anytime soon.
MARKET IMPLICATIONS
With rising risk of recession, flexible investors tipically reduce their stock exposure and focus what's left on defensive sectors, increase their fixed income portfolio weight with focus on higher quality, longer-duration government bonds, and increase their portfolio liquidity rising some cash and gold. Cartesio takes changing recession risks in consideration when confirming the day's portfolio allocations of our model portfolios or Pantarai ADAPT.
Indicators' underlying mechanics - when short-term yields exceed long-term yields, the yield curve inverts: historically, an inversion precedes a recession by 12-24 months and as soon as the inverted curve re-steepens above 0%, a recession is normally imminent. Note: The 10Y-3M spread is broadly considered a more accurate recession predictor than the 10Y-2Y. Yield curves predict a recession when they invert (the 10Y vs 3-month yields tends to be more reliable).
The US UG spread curve differential works in a similar way. It is a lesser known, quirky but solid recession indicator: when longer term spreads pay the same as (or less than) shoter-term spreads, meaning that the spread differential goes flat or negative, a recession is priced-in by the market.
US recession probability models are a more classic way to anticipate (or confirm) a recession. The Sahm Rule flags the start of a recession when the 3-month moving average of the national unemployment rate rises 0.50% or more relative to its low during the previous 12 months. The NY Fed Model uses the yield curve to forecast recession probability 12 months out.