Five Year Inflation Breakeven, Growth Prospects and Recession – Market Messages

At February 10th levels, but 10yr-2yr term spread below.

Figure 1: 10yr-3mo Treasury spread (blue, left scale), and 5yr Treasury-TIPS spread (red, right scale), both in %. Source: Treasury via FRED, author’s calculations.

The lower term spread suggests inflation expectations are the same as in February, but growth expectations lower. On the other hand, the 10yr-3mo term spread is the same on Friday as on February 10.

Current commentary seems to envision recession as pretty much a foregone conclusion. Using a simple 10yr-2yr term spread probit model, the probability of recession in May 2023 is 18%; using 10yr-3mo, it’s 2%. Adding in the Fed funds rate does not change the results appreciably. However, as noted by Ahmed, including oil prices, financial conditions, foreign term spreads can raise the probability to around 60%.