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Chances of Recession: Term Spreads vs. Term Spreads, DSR, Foreign Term Spreads


at this postal Starting Monday, I cover the results for the U.S. Chin-Ferrara(2024), using debt service ratio information as of the end of 2022. The Bank for International Settlements has now released debt service ratio data for the second quarter. I forecast the DSR for the third quarter of 2023 using a regression of DSR growth on changes in AAA and 3-month Treasury yields and 2 lags of DSR growth. I then obtained the following estimates of the odds of a recession in September 2023.

figure 1: Recession probabilities derived from term spreads and short rates (tan) and term spreads and short rates, debt service ratios, and foreign term spreads (blue). NBER-defined recession peak-to-trough dates appear gray. Source: NBER and author's calculations.

These probability estimates are based on these sequences.

figure 2: Ten-year – three-month government bond maturity spreads (blue, left axis), and long-short sovereign spreads in other developed economies, GDP weighted, both expressed as percentages (red, left axis), and other Debt ratio for non-financial corporations in advanced economies, % (cyan, right axis). Monthly DSR is linearly interpolated from quarterly data; Q3 2023 data is extrapolated as described in the text. NBER-defined recession peak-to-trough dates appear gray. Source: Treasury via FRED, Federal Reserve Bank of Dallas DGEI, BIS, NBER, and author's calculations.

By both specifications, the probability of a recession is quite high. A simple term spread plus short rate model shows 56% in February, while the full specification shows just 29%. In other words, if the full specification is more accurate (as suggested) Chin-Ferrara),So There has been no significant recession so far It should not be taken as positive evidence that a recession will be avoided. The peak probability of a recession is projected to be May 2024 (65% based on full specifications).



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