Research beginning in the late 1980s documents the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity. “Today, a substantial body of evidence exists from which various useful stylized facts have emerged,” said the Federal Reserve Bank of New York.
Importantly, this model uses the difference between 10-year and 3-month Treasury yields to calculate the probability of a recession in the U.S. twelve months ahead. The model has just been updated with data through April 11 and shows the probability of a recession for April 2010 and April 2011 to be 0.37% and 0.041% respectively (see table below). The model, in short, indicates an almost zero chance of a double-dip recession.
Source: Federal Reserve Bank of New York (hat tip: Carpe Diem).
Having said this, OECD data (including major developed and six large developing countries) show leading indicators having already peaked for this cycle. As long as the line remains above zero, there will still be positive growth, but not quite the V-shaped recovery forecast by many economists.
Source: Clusterstock – Business Insider, May 13, 2010 (hat tip: The Pragmatic Capitalist).
Are stock markets, being discounting mechanisms, already starting to focus on a less than rosy economic recovery, and thereby also less lofty growth in corporate earnings? Given the full equity valuations, slower economic and earnings growth perhaps argue for a deeper correction than what most market pundits are calling for at the moment. Caution remains!
