Recession probabilities

That is one inverted yield curve.

Recall that the yield curve “predicts” recessions. Below is 10s – 2s.

We can pop those term spreads into a probit model, and calculate the probabilitiy of recessions. If we do that, it’s high. Very high.

Now term spreads have term premia embedded in them, which is a premia that captures “everything” that isn’t explicitly the expected rates differential. People usually say stuff like “the term premia is the compensation investors demand for lending long instead of a series of shorter dated rollovers”, which is close enough. The predictive power of the above model, according to theory, is predicated on removing the impact of the term premia.

When we do that, using estimates from KW, or ACM (just people, who calculate the premia), we can see the term premia adjusted estimates have risen strongly also, noting that the KW estimate is now also predicting a recession (as 25% is about as high as it’s gotten over prior cycles).

So, the big red flag gets bigger and redder.

Important Information: This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only.

This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein.

Please note that past performance is not a reliable indicator of future performance.

General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser.

Taxation warning: Any taxation considerations are general and based on present taxation laws and may be subject to change. Aequitas is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and investors should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

Receive our investment insights

Something went wrong. Please check your entries and try again.