Term Spread Models and Recession Probabilities for April 2023

Worries about recession are rising:

Source: Google Trends, accessed 4/30/2022. 

What do we know, using indicators that have some predictive content? Using plain vanilla probit models estimated over the 1986-2022M04 period, 12 month horizon:

Figure 1: Probability of recession for indicated month, using 10yr-3mo spread (blue), using 10yr-2yr spread (brown). NBER defined recession dates peak-to-trough shaded gray. Source: Treasury via FRED, NBER, author’s calculations.

That’s for these spreads.

Figure 2: 10yr-3mo Treasury spread (blue), 10yr-2yr spread (brown), both in %. NBER defined recession dates peak-to-trough shaded gray. Source: Treasury via FRED, NBER.

Using a threshold of 50% seems natural, but that would’ve missed the 1990 recession using the 10yr-3mo. 30% for the 10yr-2yr seems like a reasonable threshold, although one would like to do a formal assessment for false positives and false negatives (i.e., AUROC). Using a 30% threshold says no recession coming. A 20% threshold could be defended, although then one would have to say there was a false positive for 1999, and that in 2020, a recession would’ve occurred even without covid.

The horizons I’m looking at are 12 month. Deutsche Bank’s prediction was for late 2023. Here’s using the 10yr-2yr 18 months ahead forecast (light blue) compared to 12 months ahead:

 

Figure 3: Probability of recession for indicated month, using 10yr-2yr spread for 12 months ahead (brown), for 18 months ahead (sky blue). NBER defined recession dates peak-to-trough shaded gray. Source: Treasury via FRED, NBER, author’s calculations.

This spread predicts 21% probability of recession in October 2023.