How do simple 10-year to 3-month and 10-year to 2-year Treasury spreads affect recession probability?
figure 1: Estimate the recession probability 12 months ahead using the 10-year to 3-month Treasury spread (blue) and using the 10-year to 2-year spread (red). Recession dates as defined by NBER are shaded from peak to trough in gray. Source: Treasury via FRED, NBER and author’s calculations.
Reflecting the vastly different trajectories of spreads, the probability estimates are also different. A common alternative norm includes the inflation-adjusted level of the federal funds rate. In the details below, I show the two predictions above and this alternative.
figure 1: 12 months ahead using 10-year to 3-month Treasury spreads (blue), 10-year to 3-month spreads, and federal funds minus ex post-lagged inflation (light blue) and using 10-year to 2-year spreads ( red) to estimate the recession probability. Recession dates as defined by NBER are shaded from peak to trough in gray. Source: Treasury via FRED, NBER and author’s calculations.
This alternative does not yield significantly different predictions.
So if past correlations persist into the future, a recession is unlikely in the next 12 months.However, it must be acknowledged that there are many different spreads that can be considered (see e.g. here).
