Foreign term spreads have inverted in several major financial centers (you can see the yield curve here). Based on 10- to 3-month term spreads, foreign (Germany, UK, Japan, Canada) 10- to 3-month term spreads, and country financial conditions index (FCI), the probability of a recession in the next 12 months What are the odds? Ahmed and Chinn (2022)?Answer: high
Using these variables, and predicting the recession 12 months out (rather than within 12 months), we find the following:
figure 1: Term spread from 10 years to 3 months (blue), 10 years to 3 months term spread widened by FCI (red), 10 years to 3 months term spread widened by FCI and foreign term Predicted recession probability for spreads (sky blue). All model estimates are between 1986M01-2023M01, except for the increase in foreign term spread, 1989M04-2023M01. FCI observations from Jan. 1 to Jan. 27; foreign term spreads as of Jan. 31, 2023. Dates of peak-to-trough recessions as defined by NBER are shaded in gray. A dashed red line with a probability of 50%. Source: NBER and authors’ calculations.
By November 2023 (October 2023 for the common term spread model), these estimates are above the 50% threshold. The FCI Enhanced Specification also predicts a recession in December 2009, but this appears to be due to the inclusion of FCI, which peaked a year earlier (November 2008). (Also, changing the specification to “within the next 12 months” instead of “within the next 12 months” removes this spike).
Here’s the spread and the Chicago National Financial Conditions Index.
figure 2: U.S. 10- to 3-month spreads (blue, left scale), foreign 10- to 3-month spreads (sky blue, left scale), all expressed as percentages, and country FCIs (red, right scale ). FCI observations from Jan. 1 to Jan. 27; foreign term spreads as of Jan. 31, 2023. Dates of peak-to-trough recessions as defined by NBER are shaded in gray. Source: Treasury Department calculations via FRED, Federal Reserve Bank of Chicago, OECD, NBER, and authors.
Interestingly, the Wall Street Journal’s October 2022 survey of economists put the chance of a recession at 49%; that rose to 63% in the January survey. (see comparison of 3m10s probit model and WSJ probability here).
