The US Federal Reserve’s recession probability model has just flashed a signal seen only 11 times since 1960.
You might be confused seeing this model show that the probability of a recession is actually going down.
This comes despite widespread panic around recession possibilities from Donald Trump’s tariff policies and one of the most aggressive stock market declines in over 3 years.
But what exactly is this model, and what does its recent move mean for the markets?
What The Model Actually Tells Us
The Fed’s recession probability model basically transforms the US yield curve (based on bond spreads) into a tool that evaluates the likelihood of a recession in the next 12 months.
It’s especially relevant today given the widespread economic concerns resulting from Trump’s proposed tariff policies.
Every time this model crosses above 20%, it means bond spreads are in a posture that makes a recession likely to happen in the near future.
In other words, it indicates the credit market is tight.
Going back to 1960, it has a solid track record at predicting recessions.
Every single recession since 1960 has been accompanied by a rising probability on this model.
On the other hand, when the recession probability is low, bond spreads suggest credit conditions are loose.
This is an environment in which the economy typically thrives.
Today’s Unusual Signal
The signal we have today is not particularly low – we’re still at about 20% probability of a recession in the next 12 months.
But, we’ve seen this model go rapidly from showing an elevated probability of a recession to a lower probability.
The elevated probability of a recession was something that concerned us throughout 2024 and kept us on high alert.
Now, with a major decline in the probability calculated by the yield curve, this is something we want to pay attention to.
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The 1999 and 1967 Scenarios
Looking back to 1960, there have been quite a few similar instances of this decline in probability.
Most occurred after recessions.
Tight conditions from the yield curve triggered a downturn, and once it materialized, credit conditions loosened again, providing the right conditions for an economic boom.
What makes this signal different is that we never actually saw a recession trigger despite this model going above 20%.
There are only 2 examples where this exact scenario has happened in history – 1999 and 1967.
In both cases, the model went above the 20% threshold but did not immediately trigger a recession, and credit conditions loosened back up again.
Looking at those two previous cases:
The September 1999 reading saw the stock market rise by another 20% over the 12 months that followed.
That eventually did end in a huge market top in 2000 as the Dot Com bubble burst.
In 1967, we saw a very similar scenario where the S&P 500 rose by 20% in the 2 years that followed.
Again, that eventually marked a significant market peak with the S&P 500 dropping by 30% in the next downturn.
In both historical cases, no recession occurred within the next year, and the stock market performed quite well.
However, in both cases, a recession was not that far off, and the next downturn was quite painful for the US stock market.
To people concerned about recent recession headlines and market declines, this message from the Fed’s own model could be a reassuring sign for the coming year.
So, despite the economic uncertainty from Trump’s policies, the yield curve – one of the most powerful macro indicators – is no longer sending a recessionary warning.
This also aligns with real economic data we’re getting on the ground.
Take small business credit conditions, for example.
Heading into recessions, small businesses often report that securing credit is getting harder
If borrowing becomes difficult, businesses are less likely to expand or hire, which could lead to an economic downturn.
In both 2023 and 2024, small businesses reported that credit was tightening.
This was a red flag for economic growth and kept us on guard for a possible recession.
But today, small businesses are reporting that credit is actually easier to get than it was a year ago.
Such a significant improvement is a positive sign for the economy.
So underneath the surface, we’re not seeing signs of an imminent economic recession.
This contradicts the current price action on the S&P 500 and could mean the recent correction is a great buying opportunity for stocks for the next year.
But as traders, when price action contradicts our analysis, we need to remain open-minded and flexible to other possibilities.
Our Market Strategy
We’ve seen the S&P 500 break through all its key moving averages in the recent correction.
This is different from previous corrections throughout 2024, which had been fantastic buying opportunities.
With this kind of technical breakdown, short-term market direction is more uncertain.
Looking back to 2010, we’ve seen plenty of 10%+ corrections outside of recessions.
So, even if we’re correct about a recession not happening in 2025, that doesn’t mean we can’t see more short-term volatility
At Bravos Research, we’ll be closely watching the next stock market bounce.
If it looks weak and fails to reclaim the key moving averages, we’ll shift to a more defensive stance or even consider shorting opportunities.
But if strength returns, we could be looking at new all-time highs.
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