The flattening yield curve has sparked worries that a new recession is near, but the near-term outlook for growth still looks healthy, based on the latest set of nowcasts for third quarter GDP, as compiled by The Capital Spectator. The median estimate points to a solid 3.3% increase for Q3 output. Although that’s down from the 4.1% advance reported in in the “advance” Q2 report,the current projection suggests that the risk of economic contraction is low for the immediate future.
The Treasury yield curve, however, appears to be signaling a different risk profile. The widely followed spread between the 10-year Treasury yield less its 2-year counterpart ticked down to 18 basis points on Monday (August 27), based on daily data from Treasury.gov – an 11-year low. The slide suggests that recession risk is rising. If and when the spread goes negative, which appears imminent, a formal recession signal will arrive.
A research note published yesterday by the San Francisco Federal Reserve advises that “in light of the evidence on its predictive power for recessions, the recent evolution of the yield curve suggests that recession risk might be rising.” But with long rates still above short rates, “the flattening yield curve provides no sign of an impending recession.” All the more so when measuring recession risk via the bank’s preferred spread: the 10-year rate and the three-month Treasury rate, which is currently 73 basis points, or moderately higher compared with the 10-year/2-year spread’s 18 basis points.
If recession risk is rising, the warning isn’t showing up in the median Q3 GDP estimate via the numbers below. The outlier on the downside is the New York Fed’s current nowcast (August 24). The bank sees growth in Q3 easing to 1.96% (seasonally adjusted annual rate), which represents less than half the pace in Q2. Yet other models currently see output increasing by 3.0%-plus in Q3. Until the New York Fed’s estimate for substantially weaker growth is confirmed from other sources, it’s reasonable to treat this warning as a noisy outlier.
