Andrew Sorkin et al. Reference to “mixed signals” about recession prospects. I thought it would be useful to plot some indicators. One is the standard term spread and the one-time credit spread.
figure 1: 10-year-3-month Treasury spread (black), 10-year-2-year spread (turquoise), and BAA-10-year Treasury spread (red), all expressed as a percentage. Data from March to March 23. Recession dates as defined by NBER are shaded from peak to trough in gray. Source: FRED, NBER and author’s calculations.
The 10-year-2-year spread narrowed considerably, but the 10-year-3-month spread didn’t – and did widen.The 18-month 3-month forward-3-month spread (not shown) backed by Chairman Powell has also widened, so the case for an initial recession is not strong
As mentioned earlier, the older conventional wisdom suggested term spreads as a leading indicator and credit spreads (the BAA-treasury spread shown in Figure 1) as a contemporaneous indicator for recessions. Here’s an extra credit spread and depicts the VIX:
figure 2: BAA-10-Year Treasury Spread (red, left scale), ICE BofA US High Yield Index Option Adjusted Spread (brown, left scale), Excess Bond Premium (light green, left scale), all in %; VIX ( light blue, right scale). Data from March to March 23. Recession dates as defined by NBER are shaded from peak to trough in gray. Source: Fred, Favara et al. (2016)NBER, and the authors’ calculations.
The BAA-10-year Treasury spread is not an ideal credit spread because it does not take into account the different maturities of corporate bonds. High yield spreads do. However, neither is adjusted for risk aversion, Giovanni Favara, Simon Gilchrist, Kurt F. Lewis and Egon Zakrajšek Excess Bond Premium (EBP) postal; Look [1], [2]). Unfortunately, the latter ended in 2016, so we cannot gain insights into the current situation from this measure. The fact that both credit spreads move together with EBP still suggests that both credit spreads and term spreads indicate an increased likelihood of a recession. However, using ordinary probabilities for the 1986-2021 sample (for comparison, in 2006M11, the implied recession probability was 29% in 2006-2021 and 38% in 2000M04).
For nostalgia, here is My September 2019 forecast for a recession in August 2020using ordinary probabilities.
