Sources of Fluctuations in Short-Term Yields and Recession Probabilities

Abstract

Why does the short-term slope of the yield curve predict recessions? In this article, we explore the economic forces underlying Treasury yields’ fluctuations and highlight the roles of a tight monetary policy stance and expectations of lower inflation in predicting downturns. While the monetary policy stance is still accommodative, indicating a low recession probability, the negative inflation slope points to higher odds of a recession within a year. An aggressive removal of policy accommodation increases the recession probability to 60%.

Keywords: yield‐curve slope, recession forecasts, monetary policy, bond risk premia, policy path, inflation forecasts, near‐term forward spread

JEL Classification: G10, G12, E32, E37, E44, E52