Why the Canadian Term Spread Model Predicted a Recession That Never Happened
Menzie Chinn, Professor of Economics at the University of Wisconsin-Madison, analyzes on Econbrowser that a Canadian 10-year minus 3-month term spread model, estimated using pre-pandemic data, should have predicted a recession in 2024 with a 40% probability threshold, but no recession occurred. The failure involves three levels: who defines the recession date (the CD Howe Institute, ECRI, and Philip Cross provide different results), how the model specification is set (debt service augmented and term premium augmented models give contradictory predictions), and historical evidence itself (since 1970, the term spread has never been so positive followed immediately by a recession).
The Canadian 10-year minus 3-month government bond term spread remained positive through September 2026. However, a term spread-recession probability model estimated on pre-pandemic data would have predicted a recession in 2024 using a 40% threshold—yet Canada did not experience a recession. The resolution to this paradox depends on three levels.
First, there is divergence in recession identification criteria—the CD Howe Institute, ECRI, and Philip Cross have identified different dates for recessions in Canada.
Second, the choice of model specification determines the conclusion: a debt service augmented regression would have predicted a recession at the 40% threshold, whereas a term premium augmented specification would not, although the latter is based on a shorter sample.
Finally, the historical evidence itself points in the opposite direction: since 1970, the term spread has never been so positive and then subsequently followed by a recession. Therefore, indicator-based evidence does not strongly suggest an imminent recession risk—but a 12-month forward-looking indicator also cannot anticipate surprises such as a sharp escalation in trade wars.