The Fed's indicators issue a warning: the probability of an economic recession reaching 70%
The economic recession warning issued by the Federal Reserve has attracted attention, with a recession probability reaching 70%. The model used by the Federal Reserve shows that the 10-year Treasury yield, 3-month Treasury yield, and current federal funds rate are key variables in predicting a recession. Although this model has shown a recession indicator of over 70% twice in the past, an economic recession did not occur. Economics professor Jonathan Wright believes that the risk of tightening monetary policy leading to a recession exists, but the predicted 70% probability is exaggerated. He believes that the Federal Reserve is still deliberately adopting a restrictive monetary policy to reduce inflation
The Federal Reserve seems to be preparing to cut interest rates soon, and concerns about economic recession are one of the reasons it hopes to lower borrowing costs. In fact, such concerns are not unfounded and are supported by the model used by the Federal Reserve itself.
This model was written in 2006. In a paper titled "Yield Curve and Predicting Economic Recession," the Federal Reserve calculated the probability of a recession in the next 12 months using only three variables: the 10-year Treasury yield, the 3-month Treasury yield, and the current federal funds rate. Now, the model shows a 70% probability of an economic recession.
However, it should be noted that since the yield curve first inverted in October 2022, this recession indicator has flashed above 70% twice, but the United States has not entered an economic recession. A U.S. political blog jokingly referred to this indicator as forming a triple top.
The author of this 2006 paper, Jonathan Wright, is now an economics professor at Johns Hopkins University. He acknowledges that the yield curve may give false signals. For example, in 2019, before the economic recession caused by the COVID-19 pandemic, the yield curve had already inverted.
In an email to MarketWatch, Wright said, "Currently, the Federal Reserve is deliberately adopting a restrictive monetary policy to curb inflation, which is the economic reason why the yield curve predicts economic recession."
Wright pointed out that the 70% probability is "exaggerated," but he also believes that there is a significant risk of tight monetary policy leading to an economic recession.
Wright said, "There are risks of economic slowdown and recession, but not immediately, but in the coming quarters. As inflation has essentially reached the target, this will allow the Federal Reserve to slightly ease off the brakes."