While last week’s consumer inflation (CPI) reading may have cracked open the window for avoiding recession, a little-known but powerful recession indicator began flashing red last week. This indicator has forecasted every recession since 1973 and has helped predict future stock returns.
While last week’s consumer inflation reading may have cracked open the window for avoiding recession, it might be too little and too late as a little-known but powerful recession indicator began flashing red last week. The 10-year Treasury minus 2-year yield is probably the most well-known predictor of recession, and it moved to red in April. Historically, when the yield on the U.S. 10-year Treasury falls below the 2-year yield, also called yield curve inverting, a recession is coming.
In 2018, the Fed published a paper about a lesser-known but more robust predictor of a pending recession. The indicator is called the “near-term forward spread.” It measures the expected three-month Treasury yield eighteen months in the future minus the current three-month Treasury rate. While this might sound complicated, the near-term forward spread reflects the bond market’s expectation of Fed rate changes over the coming year and a half.
While the 10-year minus 2-year yield curve has been inverted for some time, the near-term forward spread just inverted and produced its recession warning last week. When the near-term forward spread is negative, the market is pricing in Fed rate hikes sometime in the next year and a half, and a recession is likely coming. Further, a Fed study showed that this measure was also helpful in predicting future economic growth.
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