U.S.: Reliable Recession Signals May Have Been Lit
2022-11-02
■ Since the 26th of last month, the reversal in U.S. 3-month, 10-year Treasury yields has continued
■ Since 1970, this phenomenon has been observed every time before a recession in the United States
On the 26th of last month, U.S. 3-month and 10-year Treasury yields reversed and have continued to show reversals since then as well. The spread between long-term and short-term interest rates between these two periods is the indicator used by the New York Fed to calculate the probability of a recession over the next 12 months.According to the published values of the Union Bank of New York, after 1970, 8 degrees of recessionary situations in the U.S., all preceded by about 1 year, based on monthly averages, during which 3-month and 10-year U.S. Treasury yields were reversed. The history of avoiding recessions following reversals in 3-month and 10-year long and short-term interest rates was not observed until 1966. Based on these facts, the reliability of the indicator as an early warning indicator is very high, which means that if the spread reversal is not resolved, the probability of entering a recession increases.
So can we expect another reversal in US 3-month and 10-year Treasury yields soon? If we start with the conclusion, it is highly unlikely, although not completely negative. The 3-month U.S. Treasury yield is about 4.09% (Oct. 31 close), and these moves will continue to factor in additional interest rate hikes from November onward. The policy rate is expected to be raised to 3.75-4.00% over the next three months at the November 1-2 Federal Open Market Committee (FOMC) meeting, with further increases at the December 13 FOMC meeting. Based on purely prospective assumptions, regardless of the pace of rate increases beyond December, the rising tone in U.S. 3-month Treasury yields will not be until the end of the rate hike Stop*1.
On the other hand, this assumption makes a relatively very small contribution to the 10-year U.S. Treasury yield and reflects other factors such as future interest rate cuts. As a result, U.S. 10-year Treasury yields typically converge with the medium- to long-term equilibrium levels of potential growth and expected inflation. With this status quo, the U.S. 10-year Treasury yield is rising at a rate that exceeds the U.S. 3-month Treasury yield, with a very high threshold for another early reversal in the two-year horizon.
The reversal in U.S. 3-month and 10-year Treasury yields also means that the Federal Reserve (FRB) is moving into areas where future monetary policy could overkill the economy. The Fed will have to seriously consider the trade-off between the economy and inflation, and when and how to make policy adjustments will face a more difficult situation.
*1 This is because the level of interest rates is determined based on the assumption that for each day that passes, the duration of operation at the current next-day rate decreases by one day, and three months later the duration of operation at a higher next-day rate increases by one day instead. However, if the pace of rate increases slows, the rate of increase in three-month Treasury yields will also slow.