A Mild Recession Expected This Year: Constance Hunter

Constance Hunter, Chief Economist at EIU, joins to discuss the markets. She also talks about whether the US is staring down a financial crisis as President Trump negotiates trade deals with other countries.

The volatility regime has already normalized to the degree that Monday’s equity-market price action almost felt a little boring, at least in comparison to the prior couple of weeks. I guess when you spend a day riding roller coasters, the drive home always feels a little sedate. Mind you, Treasury-market price action is still pretty frisky, though you could say that that represents the “right” kind of volatility, with yields dropping sharply on Monday and swap spreads snapping tighter. For now at least, the “Sell America” theme is in abeyance.

Growth and recession concerns, however, remain very much in evidence. It’s true that the stock market is not the economy, and by extension the economy is not the market. Still, there is a correlation between the two that allows us to hypothesize what will happen should the US economy contract.

There is a lot of pessimism out there. While some individuals may truly believe that US tariff policy is on the right track, in aggregate the reaction from US consumers at least has been overwhelmingly negative. Last week’s UMich expectations index printed at its lowest level since 1980, and the overall confidence level of political independents is now worse than it was at the height of the 2022 inflation episode. It still remains to be seen, however, whether negative thoughts are put into action (or lack thereof, when it comes to spending.)

Over the last few weeks I’ve been asked a few times about the market-implied recession model that we’ve discussed in this commentary over the years. As a reminder, it takes inputs from the Treasury, credit, and equity markets and generates an estimated probability of a US recession over the next 12 months based on historical relationships. I haven’t really referenced it recently because in a sense, it has broken. The lengthy inversion of the yield curve (itself informed by Fed guidance) has generated a permanent recession signal for nearly two years now. It’s the analytical equivalent of a stopped watch; there’s no real point consulting it because you know what it’s going to say.

We saw similar early warnings in the 1990s and before the GFC, albeit not as extreme. Still, that doesn’t mean that markets have nothing to tell us about the economic cycle. As noted above, Fed guidance has had an impact on the yield curve in recent years; when the dot plot shows that the level of short rates is way above the long-run equilibrium, is it any wonder that the Treasury curve was inverted for an extremely long time? That was ultimately the source of the recession-model output above, given that recessions have usually followed swiftly behind inversions.

However, as this commentary often remarks, it’s not the inversion that gets ya, it’s the subsequent re-steepening. Tariff policy has provided that in spades. While most studies of the yield curve and recession tend to focus on bill yields relative to 5s or 10s, let’s look a little further afield at the 2s-30s. Using daily data since 1977, I looked at the three-month change in that curve and compared it with the chances that the US economy entered recession within the next six months. The recent peak steepening of 39 bps is consistent with a roughly 50% chance of recession.

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