Do you ever get the feeling that the officials who operate the Federal Reserve are getting their advice on how to set interest rates from really bad carnival psychics?

Since they stopped cutting interest rates in December 2024, the probability of a recession starting in the U.S. has risen. That's according to a recession forecasting method developed by Jonathan Wright while working for the Federal Reserve Board back in 2006. The method, which incorporates the yields of constant maturity 10-year and 3-month U.S. Treasuries and also the level of the Federal Funds Rate, which the Fed sets, can provide a good indication of the relative risk of a recession starting in the next 12 months based on historic data.

After having been elevated at probabilities exceeding 70% through much of 2023 and 2024, the recession forecasting model's projections only begin to drop when the Fed started cutting interest rates in September 2024, ahead of the U.S. elections. The Fed continued cutting interest rates through December 2024, then stopped.

The probability a recession would start in the U.S. during the next 12 months dropped to as low as 21.8% on 7 March 2025, then began rising again. Six weeks ago, it had risen back up to 25.9%. For this update, we find it is still in that ballpark, having dipped slightly to 25.5%. The latest update of the recession probability track shows how the probability of recession has evolved since 20 January 2021 in the context of how the difference between the yields of the 10-year and 3-month U.S. Treasuries combined with the level of the Federal Funds Rate have changed over this time.

This newest estimate applies to the probability the NBER will someday pick a month between 16 June 2025 and 16 June 2026 as the starting point for a period of economic contraction for the U.S. economy.

If Federal Reserve officials had continued their 2024 election season rate cuts, the probability of recession would have dropped well below the 20% threshold by now. These officials claim they're worried about the potential for inflation from President Trump's reciprocal tariffs, which has yet to materialize in the inflation data even though those new tariffs were put into effect in early April 2025.

Looking forward, we anticipate the forecast recession probability will remain around this level in the near term because Federal Reserve officials are expected to continue their pause in rate cuts into September 2025. At present, the CME Group's FedWatch Tool projects the Fed will wait until 17 September (2025-Q3) to cut the Federal Funds Rate by a quarter point, which will be followed by more quarter point reductions at 12 week intervals going into 2026.

Unless a deep inversion of the U.S. Treasury yield curve were to develop in the weeks ahead, we think the forecast recession probability will likely remain near its current level until the Fed resumes cutting short-term U.S. interest rates.

We will continue following the Federal Reserve's Open Market Committee's meeting schedule in providing updates for the Recession Probability Track until the U.S. Treasury yield curve is no longer inverted and the future recession odds retreat below a 20% threshold.

Analyst's Notes

The recession probability we've presented is based on the Federal Reserve Board's yield curve-based recession forecasting model, which factors in the one-quarter average spread between the 10-year and 3-month constant maturity U.S. Treasuries and the corresponding one-quarter average level of the Federal Funds Rate. If you'd like to do that math using the latest data available to anticipate where the Recession Probability Track is heading, we have provided a tool to make it easy to do.

Previously on Political Calculations

We started this new recession watch series on 18 October 2022, coinciding with the inversion of the 10-Year and 3-Month constant maturity U.S. Treasuries. Here are all the posts-to-date on that topic in reverse chronological order, including this one....

• U.S. Recession Odds Holding Mostly Steady with Fed Holding Off on Rate Cuts
• U.S. GDP Contracts as Recession Odds Tick Up with Fed on Hold
• Decline in U.S. Recession Odds Stalls with Pause in Fed Rate Cuts
• U.S. Recession Probability Plunges to 27%
• U.S. Recession Probability Drops Below 50%
• U.S. Recession Odds Fall with Fed Rate Cut, But Are Still Elevated
• Triple Top Pattern Locking In for U.S. Recession Probability
• Triple Top Developing for U.S. Recession Probability
• U.S. Probability of Recession in Next Twelve Months Hovers Near 70%
• Recession Probability Falls After Hitting Double-Top
• U.S. Recession Probability Nears a Double-Top
• Probability of U.S. Recession Resurges to Nearly 75%
• U.S. Recession Odds Recede to Two Out of Three Chance in 2024
• U.S. Recession Probability Continues Receding on All Hallow's Eve
• U.S. Recession Probability Starts to Recede
• Probability of Recession Starting in Next 12 Months Breaches 80%
• U.S. Recession Probability on Track to Rise Past 80%
• U.S. Recession Probability Reaches 67%
• U.S. Recession Probability Shoots Over 50% on Way to 60%
• Recession Probability Nearing 50%
• Recession Probability Ratchets Up to Better Than 1-in-6
• U.S. Recession Odds Rise Above 1-in-10
• The Return of the Recession Probability Track

Image Credit: Microsoft Copilot Designer. Prompt: "An editorial cartoon of a Federal Reserve official consulting a psychic about whether to cut interest rates or not". We very slightly modified the text spoken by the psychic.

The S&P 500 (Index: SPX) was on track for a winning week. Until Friday, 13 June 2025, when geopolitical events took over the headlines for market moving news.

The outbreak of military action by Israel to decapitate Iran's military and nuclear weapons program in the Middle East was the catalyst for reversal, which was followed up by Iran's ballistic missile counterattack. But despite the dramatic events, their effect on the U.S. stock market was not significant. The S&P 500 lost 1.13% from Thursday's close, putting the index at 5,976.97. The S&P 500 closed the week down about 0.4% from the preceding week.

The daily change puts the day's decline on par with the typical day-to-day percentage change recorded by the S&P 500 as measured by its standard deviation since January 1950. Which is to say that if you didn't know anything about the geopolitical turmoil and its effect on investor reactions from the index' futures and intraday trading, you wouldn't necessarily think anything unusual was afoot. It looks like typical day-to-day noise.

In a statistical sense, it takes at least a two percentage point change from the previous day's change for the market action to even qualify as interesting.

What was more interesting however is the day's market action pushed the trajectory of the S&P 500 down the lower end of the expected range the alternative futures chart's projected range for where the index would be assuming investors are focusing their forward looking attention on 2025-Q4. The latest update of the chart shows that relative position:

Although it's only encompassed one day of trading, the geopolitical events in the Middle East do have the potential to contribute something more than noise to how U.S. stock prices behave. One thing to pay close attention to is oil prices, which jumped on the news and which can affect a significant portion of the U.S. stock market.

Outside the geopolitical news, there were few market moving headlines to affect the direction of stock prices, and that includes the announcement of a deal between the U.S. and China on tariffs along with lower than expected inflation data. Here are the headlines we noted during the week that was.

Monday, 9 June 2025

• Signs and portents for the U.S. economy:
• Oil prices steady ahead of US-China trade talks
• US ocean container imports tumble in May as China tariffs take hold
• Aluminium producers in the US win from Trump's tariffs
• US-China trade talks to resume for a second day
• Fed minions get data that says Americans are expecting lower inflation:
• US inflation expectations ease in May, New York Fed survey shows
• Inflation Expectations Tumble As Latest NY Fed Survey Suggests Fed Late To Cut
• Inflation Is Back to Normal
• Bigger trouble, stimulus developing in China:
• China's exports slow, deflation deepens as tariffs bite
• China's factory-gate deflation worst in 22 months as economic headwinds mount
• China's car sales rise in May, but price wars cloud outlook
• China's rare earth exports jump 23% in May despite export curbs
• BOJ minions discover Japan's GDP didn't shrink as much as previously reported:
• Japan's first-quarter GDP contraction narrows on consumption improvement, revised figure shows
• ECB minions disappointed they may have to stop cutting Eurozone interest rates, acknowledge they're coupled to the Fed:
• ECB is 'nearly done' with cuts if forecasts hold, Vujcic says
• ECB's Schnabel sees no lasting decoupling from Fed
• Nasdaq, S&P, and Dow finished trading muted as inflation data now looms
• S&P 500 ends slightly up; traders watch US-China trade talks

Tuesday, 10 June 2025

• Signs and portents for the U.S. economy:
• Oil prices hold near 7-week high as market waits for news from US-China trade talks
• Fed minions expected to not change interest rates until September 2025:
• Fed to keep rates on hold at least until September as inflation risks linger
• Bigger trouble developing in China:
• Price wars grip China as deflation deepens - $30 for a luxury Coach bag?
• Chinese state media calls for crackdown on 'zero-mileage used cars'
• BOJ minions hear good news about inflation, and also hear Japanese politicians want them to lower their inflation target:
• Japan wholesale inflation slows, taking pressure off BOJ
• Japan's largest opposition calls for lowering BOJ's inflation target
• ECB minions claim they'll be agile in adapting policy, say Eurozone governments need to make trade deals:
• ECB will be as "agile" as needed in line with data flow- Villeroy
• Trade war resolution may require concessions from all, ECB's Lagarde says
• Wall Street ends higher, less than 2% away from record close
• Wall Street ends higher as investors track US-China trade talks

Wednesday, 11 June 2025

• Signs and portents for the U.S. economy:
• US consumer prices rise moderately in May
• May CPI Review: Inflation Continues To Defy Tariffs
• Trump says Fed should lower rates by 'one full point'
• US-China trade deal is 'done,' Trump says
• US, China reach deal to ease export curbs, keep tariff truce alive
• Trump tariffs may remain in effect while appeals proceed, US appeals court rules
• Oil prices climb to 2-month high on US-China trade deal, worries about Iran supply
• Fed minions expected to cut interest rates in September 2025:
• Fed seen on track to start cutting rates by September
• Hopes for Fed rate cuts keep US Treasury yield views low ahead of supply deluge: Reuters poll
• Trump says Fed should lower rates by 'one full point'
• Bigger trouble, stimulus developing in China:
• As US trade truce gets back on track, some Chinese exporters are 'slowly dying'
• Chinese automakers pledge to make payments to suppliers within 60 days
• China Taps $1.5 Trillion Fund To Offer Cheap Mortgages, Boost Housing Demand
• BOJ minions likely to hold off on more rate hikes until 2026, worry about tariff impact:
• BOJ to postpone rate hike to Q1 next year, tiny majority of economists say: Reuters poll
• Japan remains cautious on tariff impact in June econ report
• Wall Street snaps three-day win streak amid lack of details on China trade deal
• S&P 500 ends lower; traders focus on Middle East tension and await details on trade deal

Thursday, 12 June 2025

• Signs and portents for the U.S. economy:
• US producer prices rebound less than expected in May
• PPI Shows Companies Eating Tariff Costs, Bloomberg Finds
• Oil prices drop as traders gauge Middle East tensions
• Fed minions expected to deliver rate cuts after inflation comes in lower than expected, can expect pressure from the White House:
• Fed seen on track to resume rate cuts after inflation, job market data
• Fed rate cut expectations rise on soft inflation data, signs of labor market cooling
• Trump says he won't fire Fed's Powell but 'may have to force something' on rates
• BOJ minions thinking about putting rate hike ambitions on hold:
• US tariffs may have ended BOJ's rate-hike cycle, former policymaker says
• ECB minions counting on Germany to stop dragging Eurozone economy down, say their monetary policy is in a 'good place', want to cooperate with China:
• Germany to return to growth after two years of contraction, economists predict
• ECB monetary policy is in a 'good place' now, says ECB's Schnabel
• China eyes stronger cooperation with ECB amid global trade tensions
• S&P ends higher, bonds rally after soft PPI and strong Treasury auction
• Yields slide as traders snap up bonds after more soft inflation data
• S&P 500 ends higher as Oracle reignites AI rally; Boeing drops
• Oracle pops as Q4 results top estimates, offers outlook for fiscal 2026
• Boeing's stock falls as Air India crash raises more safety questions

Friday, 13 June 2025

• Signs and portents for the U.S. economy:
• Israel launches strikes against Iran nuclear, military sites
• Oil settles up 7% as Israel, Iran trade air strikes
• OPEC+ would struggle to cover major Iranian oil supply disruption
• Big disruption to oil supply unlikely after Israel's attack on Iran, say analysts
• Bigger trouble, stimulus developing in China:
• China solar industry to address overcapacity challenge but turnaround far off, experts say
• Possible trade deal with US developing in Japan:
• Japan and US explored possibility of trade deal, Japan trade negotiator says
• Bigger trouble developing in Eurozone:
• Euro zone industry, trade take big hits in April amid tariff turmoil
• Dow tumbles nearly 800 points, S&P sheds over 1% as Israel-Iran conflict escalates
• Wall St ends sharply lower as Iran retaliates against Israel attack

The CME Group's FedWatch Tool continues to project the Fed will not cut the Federal Funds Rate until the conclusion of its 17 September (2025-Q3) meeting, at which time, it will cut rates by a quarter percent to a target range of 4.00-4.25%. There was also no change in the longer run forecast, as the FedWatch Tool anticipates the Fed will continue reducing U.S. interest rates at twelve-week intervals with quarter point cuts coming on 10 December (2025-Q4) and 18 March (2026-Q1).

The Atlanta Fed's GDPNow tool projection of real GDP growth in the U.S. during the current quarter of 2025-Q2 held steady at +3.8%.

Image credit: Microsoft Copilot Designer. Prompt: "An editorial cartoon of a Wall Street bull and bear who are reacting to news of geopolitical events". We tweaked the word "geopolitical" in the headline to overcome how it was originally spelled.

Ever since the call option was invented by Thales of Miletus about 26 centuries ago, savvy investors have used these and similar financial instruments to make money.

But even though options have been around for a very long time, it wasn't until the last 12 decades and mostly within the last 60 years, in which the math needed to determine what their price should be was finally developed.

In the following 31-minute video, Veritasium's Derek Muller explains the origins of options and the Nobel-prize winning development of the math behind what became the world's first trillion dollar equation. Which turned out to be closely related to the math physicists use to describe the diffusion of heat.

This being a video from the modern internet, there's a mattress commercial built into the middle of the video. If you jump to the 16:02 mark after it starts, it is something you can skip past, unless you're perhaps in the market for a mattress.

In any case, the story is fascinating, because it also involves the one of the most successful investment managers of all time, a mathematician who earned that title by betting against the widely believed efficient market hypothesis by uncovering not-so-random patterns within it and using options to realize gains to beat the market year after year.

The pace at which the concentration of carbon dioxide in the Earth's atmosphere is increasing picked up in May 2025, fully reversing the downward trend that began after December 2024.

The latter half of 2024 had seen record high levels of CO₂ accumulation in the Earth's air thanks largely to efforts by Chinese firms to produce and export as many goods as they could ahead of new tariffs and trade restrictions that were expected to be imposed on China-produced goods. Industrial production slumped in China following its efforts to front-run (or front-load) their exports before these anti-free trade measures were implemented. Since China is by far and away the world's biggest producer of carbon dioxide emissions, changes in its economic output directly affect the rate at which the concentration of CO₂ changes.

From January 2025 through March 2025, the rate of CO₂ accumulation fell, before stalling in April. The data for May 2025 however shows it rose, which suggests a new effort to stimulate China's economy began in early April. This timing coincides with President Trump's "Liberation Day" tariff announcement, which saw the U.S.' highest tariff rates applied to goods produced in China, which then escalated even higher as China imposed retaliatory tariffs on U.S.-produced goods and the U.S. responded in kind.

The following chart, which tracks the trailing twelve month average of the year-over-year change in the rate at which the concentration of carbon dioxide measured at the remote Mauna Loa Observatory has changed from January 2000 through May 2025, shows the reversal:

The January-March 2025 downturn also coincides with a quarter of negative real economic growth in the U.S., which was highly influenced by the frontrunning (or front-loading) of exports to the United States following their production in China in 2024.

On the stimulus side of the story, there are several developments that indicate unusual interventions by China's government is behind the increase in CO₂. First, China's government has approved new coal-fired power plants:

China approved 11.29 gigawatts (GW) of new coal power capacity in the first quarter of 2025, Greenpeace’s review of official documents showed. This pace of coal-fired electricity approvals already exceeds the 10 GW China approved in the first half of 2024.

Second, China's coal-fired power plant managers have been directed to buy more coal, even though China's economy has slowed and its demand wouldn't support it unless part of a larger stimulus effort:

China is pressing its coal-fired power plants to stockpile more of the fuel and import less in an effort to shore up domestic prices, sources with knowledge of the matter said, but traders are sceptical the measures will help to stop the slide.

The coal industry in China faces rising stockpiles of the fuel after a massive expansion of output following shortages and blackouts in 2021 is churning out more coal than even the world's largest thermal power fleet can consume.

To support miners whose profits are under pressure, the state planner has asked power plants to prioritise domestic coal and increase thermal coal stockpiles by 10%, setting an overall target of 215 million metric tons by June 10, the sources said.

Third, China announced earlier it will build additional coal-fired power generation capacity to compensate for gaps in the reliability of power produced by renewable energy sources. The announcement will see China continue producing coal-fired power plants through 2027 and represents a significant stimulus initiative.

On that final count, the world had a wake-up call from the collapse of Spain and Portugual's electricity grid on 28 April 2025, which was caused by unstable solar energy production and ensured by the absence of more reliable conventional fossil-fuel or nuclear-based power generation. China's government is backing increased coal-fired electricity production as a solution to this problem in the near term.

References

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. [Online Data]. Updated 5 June 2025.

Image credit: Shuozhou coal power plant in Shuozhou, Shanxi, China by Kleinolive on Wikimedia Commons. Creative Commons CC by-SA 3.0 Attribution 3.0 Unported Deed.

As expected, there was a dramatic deviation in the level of trade between the U.S. and China in April 2025.

The combined value of goods exchanged between the two nations plunged 17.8% from their level in March 2025, from $40.8 billion to $33.6 billion. Year-over-year, the decline is even larger, at 22.2%.

April 2025's plunge in trade is also large enough to affect the trajectory of the trailing twelve month average of the combined value of goods traded between the U.S. and China. We find the trailing twelve month average of trade between the two nations is $47.7 billion. That figure compares with our counterfactual projection for this month based on the trajectory of trade between the two nations from March 2024 through March 2025 is $48.9 billion. April 2025's deviation is $1.2 billion.

The following chart presents the monthly figures for the combined value of goods exchanged between the U.S. and China with the trailing twelve month average and counterfactual projection of the trailing twelve month average through April 2025.

We anticipate the deviation between our counterfactual and the actual trajectory of trade between the U.S. and China will continue growing when May 2025's trade data becomes available next month.

References

U.S. Census Bureau. U.S. International Trade in Goods and Services (FT900). U.S. Trade in Goods with China, Not Seasonally Adjusted, Nominal Figures, Total Census Basis. [Online database]. Accessed 5 June 2025.

Image Credit: Microsoft Copilot Designer. Prompt: "An editorial cartoon of a container ship from the U.S. and another container ship from China that are both half empty and heading in opposite directions". We modified the image with a second prompt: "Only show one container on the U.S. ship and show two containers on the China ship. Also make the picture more colorful", which didn't work as well as intended, but the image produced does get across a sense of the relative difference in cargo volume transported in each direction between the two nations.