Analysis Overview – The yield spread (10-year Treasuries minus three-month Treasuries) is a good indicator of economic slowdown or potential recession and this article discusses recession probability from yield spread perspective.
The chart below gives the yield spread from 1959 to February 2016.
It is important to note that in all recent instances of recession, the yield spread has turned negative just before recession. Therefore, current yield spreads of does not indicate recession in the foreseeable future, but the yield spread has declined from 2.01% in December 2015 to 1.47% by February 2016.
This is indicative of meaningful slowdown in economic activity and it remains to be seen if yield spreads continue to trend lower in the coming months. It can also be conclude from the above data that recession probability in the next 12 months has increased meaningfully in the last two months.
The reason for focusing on this chart is that the President of St. Louis Fed, James Bullard, recently opined that the next rate hike might not be far off. However, when policymakers meet, recent economic weakness will be the key reason to stay away from another rate hike.
The dollar, which has gained in strength in the last few trading sessions, is likely to weaken when there is more clarity from the policymakers that rate hike is not coming anytime soon. It however remains to be seen if US slips into recession towards the end of 2016. The CFO survey does indicate that 31% CFOs believe that US is likely to enter into recession by the end of 2016.
