The DoJ Hacked, DHS Files Compromised

Hackers leaked DHS staff records, 200GB of files are in their hands

A hacker accessed an employee’s email account at the Department of Justice and stole 200GB of files including records of 9,000 DHS staffers and 20,000 FBI employees.

SecurityAffairs: Yesterday, the data related a Department of Homeland Security (DHS) staff directory were leaked online, a Twitter account shared the link to an archive containing 9,355 names.

The responsible for the data leakage first contacted Motherboard to share the precious archive.

Each record of the DHS Staff Directory includes name, title, email address, and phone number.

Going deep in the archive it is possible to note that it includes information of DHS security specialists, program analysts, InfoSec and IT and also 100 employees with a title “Intelligence”.

The same Twitter account has announced later the imminent release of an additional data dump containing 20,000 FBI employees.

DHS firewall

Are the records authentic?

Motherboard that obtained the archive reached the operations center of the FBI, and in one case the individual who pick up the phone presented himself with the same name associated with that number in the archive. A similar circumstance occurred with a DHS employee, Motherboard so confirmed that the information is legit.

Which is the source of data?

According to Motherboard, a hacker accessed an employee’s email account at the Department of Justice. As proof, the hacker sent the email message to Motherboard’s contributor Joseph Cox directly from the compromised account.

“A hacker, who wishes to remain anonymous, plans to dump the apparent names, job titles, email addresses and phone numbers of over 20,000 supposed Federal Bureau of Investigation (FBI) employees, as well as over 9,000 alleged Department of Homeland Security (DHS) employees, Motherboard has learned.” wrote Cox in a blog post.

“The hacker also claims to have downloaded hundreds of gigabytes of data from a Department of Justice (DOJ) computer, although that data has not been published.”

The hacker first tried to use the compromised credentials to access a DOJ staff portal, but without success, then he called the department directly and obtained the access through social engineering techniques.

The hacker accessed the DoJ intranet where the database is hosted, then he downloaded around the, out of 1TB that he had access to.

“I HAD access to it, I couldn’t take all of the 1TB,” the hacker told to MotherBoard.

The hackers confirmed his intention to release the rest of the data in the near future.Which is the motivation behind the attack?

It is not clear at the moment why the hacker released the archive, surely it’s not financially motivated. The hacker only left the following message when has leaked the data-

“This is for Palestine, Ramallah, West Bank, Gaza, This is for the child that is searching for an answer…” which are the verses of “Long Live Palestine”

The only certainty right now is that similar incidents are becoming too frequent, apparently the government staff is not properly trained on the main cyber threats or the hacking technique. Similar incidents show the lack of knowledge on the most basic security measures.
Whenever a hacker leaks so sensitive data, I think the number of his peers who had access to the same information with the intent to use them in other attacks or resell them, perhaps to a foreign government.

Pierluigi Paganini

*** As a reminder, in 2014 a much more dangerous hack intrusion happened at the DHS:

The Department of Homeland Security (DHS) alerted critical infrastructure operators to recent breaches within the sector – including the hack of a U.S. public utility that was vulnerable to brute-force attacks.

This week, the Industrial Control Systems Cyber Emergency Response Team (ICS-CERT), a subgroup of DHS, revealed information about the incidents in a newsletter (PDF).

According to ICS-CERT, industrial control systems were compromised in two, new incidents: one, involving the hack of an unnamed public utility, and another scenario where a control system server was remotely accessed by a “sophisticated threat actor.”

After investigating the public utility hack, ICS-CERT found that the system’s authentication mechanism was susceptible to brute-force attacks – where saboteurs routinely run through a list of passwords or characters to gain access to targeted systems. The control system used a simple password mechanism, the newsletter revealed.

In

Hey Janet and Jeh, How do you Square This?

May 2015, speech in part: DHS Secretary Jeh Johnson, “The FBI continues to identify, investigate, interdict and help the Department of Justice prosecute attempted terrorist plots to the homeland. With the help of DHS, the FBI has also made a number of arrests of those who attempt to become foreign fighters, before they can get on an airplane and leave the country.

In reaction to terrorist groups’ public calls for attacks on government installations in the West, and following the attack last fall in Ottawa, I directed that our Federal Protective Service enhance its security and presence at federal office buildings around the country. This enhanced security remains in place.

In reaction to terrorists’ public calls for attacks on U.S. military installations and personnel, the Department of Defense has enhanced its security at bases in the U.S.

Given the new reality of the global terrorist threat — which involves the potential for small-scale homegrown attacks by those who could strike with little or no notice, we are working in closer collaboration with state and local law enforcement. Given the nature of the evolving threat, the local cop on the beat may actually be the first to detect a terrorist attack on the homeland.

So, as often as several times a week, the Department of Homeland Security and the FBI share terrorist threat information and intelligence with Joint Terrorism Task Forces, state fusion centers, and local police chiefs and sheriffs.” Full speech here and note the some of the attendees.

Maybe we should be seeking a subpoena of Janet Napolitano and Jeh Johnson.

***

Enter Philip Haney, again:

DHS Official: I Was Ordered to Purge Records of Islamic Terror Ties
A veteran official with the Department of Homeland Security claims he and other staff were ordered to destroy records on a federal database that showed links between possible jihadists and Islamic terrorist groups.

“After leaving my 15-year career at DHS, I can no longer be silent about the dangerous state of America’s counter-terror strategy, our leaders’ willingness to compromise the security of citizens for the ideological rigidity of political correctness—and, consequently, our vulnerability to devastating, mass-casualty attack,” the former employee, Patrick Haney, wrote in an explosive column that was published late Friday on The Hill website.

Haney alleges that the Obama administration has been “engaged in a bureaucratic effort” to destroy the raw material and intelligence the Department of Homeland Security has been collecting for years, leaving the United States open to mass-casualty attacks.

His story starts in 2009, when during the holiday travel season, a 23-year-old Nigerian Muslim,  Umar Farouk Abdulmutallab, boarded Northwest Airlines Flight 253, with explosives packed in his underwear and the hopes of slaughtering 290 travelers flying on Christmas Day from the Netherlands to Detroit, Michigan. Passengers subdued the jihadist and he was arrested, thwarting the plot.

After the attempt, Haney writes, President Barack Obama “threw the intelligence community under the bus for its failure to ‘connect the dots,’ saying that it was not a failure to collect the intelligence that could have stopped the attack, but rather “‘a failure to integrate and understand the intelligence that we already had.'”

But most Americans were not aware that the Department of Homeland Security’s employees suffered enormous damage to their morale from Obama’s words, Haney said.

Further, many were infuriated “because we knew his administration had been engaged in a bureaucratic effort to destroy the raw material — the actual intelligence we had collected for years, and erase those dots. The dots constitute the intelligence needed to keep Americans safe, and the Obama administration was ordering they be wiped away.”

Just one month before the attempted attack, Haney said, his DHS supervisors ordered him to either delete or modify the records for several hundred people tied to Islamist terror organizations, including Hamas, from the Treasury Enforcement Communications System, the federal database.

Those records give DHS the ability to “connect dots,” explained Haney, and every day, the agency’s Custom and Border Protection officials use the database while watching people who are associated with known terrorist affiliations seeking patterns that could indicate a pending attack.

“Enforcing a political scrubbing of records of Muslims greatly affected our ability to do that,” said Haney.

“Even worse, going forward, my colleagues and I were prohibited from entering pertinent information into the database,” he wrote.

And even weeks after the attempted Christmas Day attack, Haney said, he was still being ordered to delete and scrub terrorists’ records, making it more difficult to connect dots in the future.

The number of attempted and successful Islamic terrorist attacks kept increasing, notes Haney, including the 2013 Boston Marathon bombing, conducted by Dzhokhar and Tamerlan Tsarnaev; Muhammad Youssef Abdulazeez’ shooting of two military installations in Chattanooga, Tennessee last year; the attack conducted by Faisal Shahzad in May 2010; Detroit “honor” killer Rahim Alfatlawi in 2011; Amine El Khalifi, who plotted to blow up the U.S. Capitol in 2012; and Oklahoma beheading suspect Alton Nolen in 2014.

He believes it is “very plausible” that one or more of those homeland incidents could have been prevented, if DHS subject matter experts had been allowed to keep doing their jobs.

“It is demoralizing — and infuriating — that today, those elusive dots are even harder to find, and harder to connect, than they were during the winter of 2009,” Haney concluded.

 

 

 

 

 

 

The Unknown Soldier in St. Louis

Hey VA, how about you prove he wasn’t in the service…sheesh

1944, Philippines: Emil Limpert

He was patched up in a jungle tent and sent back to his unit. He received help from a veterans group and was able to provide plenty of documentation.  Limpert, a bit of a packrat, saved all his old paperwork.  He had his discharge papers, a roster of those injured in the attack, and the X-ray taken of his leg after he returned home.  On top of that he had the two bronze stars and the purple heart he earned in combat.

All that information was, with the help of a veterans service group called AMVETS, was sent to the Veteran’s Administration to apply for benefits.  After two months of waiting he received a letter from the VA saying he needed to provide more proof.

VA demands proof World War II combat vet with Purple Heart served in military

Fox2: The Veterans Affairs Department refuses to pay benefits to a World War II vet in his 90s who was wounded in combat and earned a Purple Heart.

Fox 2 Now in St. Louis reports that after Emil Limpert submitted an application for benefits to the Department of Veterans Affairs he was told he needed to provide more proof that he was in the military.

“I get this letter that says we can’t accept it because we’ve got no record of you being in the service,” he told the station. “I guess I’m the unknown soldier.”

He was wounded in a foxhole in the Philippines in 1944.

“There were four guys in there, and two guys got killed,” he told the station. “And then the other guy, he got his leg… Oh, hell. I guess he lost his leg. It was slit in four places where a grenade hit between us and I got one in my leg.”

Limpert said he waited until now to apply for benefits because he is down to nothing.

He and his wife live in an assisted-living facility outside St. Louis.

“We got rid of our car, we got rid of our house,” he said. “I got rid of money I had in bonds and stocks and now I need help.”

His application included plenty of documentation, including discharge papers, the names of his foxhole pals and the X-ray of his wounded leg. The proof also included his Purple Heart and two Bronze Stars he received in the Pacific.

Fox 2 reported the VA letter asks Limpert to submit affidavits from fellow service members, most of whom are dead, or the location of the hospital where he was originally treated.

“There ain’t no hospital,” he told the station. “We were in the jungles.”

The station reported that Limpert’s military records were apparently among the millions destroyed in a massive fire in Overland, Missouri, in 1973.

The station also reported that it sought comment from the VA in Washington without success.

Limpert has now turned to his local senator for help in the matter.

Beatles and London Boys and Militant Islamists

Unmasked: The Second Member Of ISIS’s “Beatles” Execution Cell

BuzzFeed-Exclusive: Alexanda Kotey is the second member of the notorious ISIS cell led by “Jihadi John” to be identified.

A second member of the notorious ISIS execution cell once headed by “Jihadi John” has been unmasked as a “quiet and humble” football fan from west London, BuzzFeed News and the Washington Post can reveal.

Thirty-two-year-old Alexanda Kotey has been identified by British and American intelligence services as one of four ISIS guards, collectively known as the “Beatles”, who are responsible for beheading 27 hostages. The guards were given their nickname by hostages because of their British accents.

It can be revealed that Kotey travelled to the Middle East alongside three other known extremists on a controversial aid convoy to Gaza organised by the London mayoral candidate George Galloway in 2009 – and friends in west London have not heard from him since.

He is the second member of the cell to be identified, after “Jihadi John” was exposed as west Londoner Mohammed Emwazi, who was killed by US a drone strike in November. The other members of the cell, nicknamed “Ringo”, “George”, and “Paul”, remain among the world’s most wanted men and are being hunted by intelligence and security services on both sides of the Atlantic.

A US intelligence official confirmed that Kotey had travelled to Syria and said his role in the taking of Western hostages was being investigated. A UK security official declined to comment.

It is not clear whether Kotey is the guard nicknamed “Ringo”, who has previously posted online about growing up in west London’s Shepherd’s Bush area, or “George”, identified by some hostages as a senior figure in the group. There are understood to be discrepancies in the accounts of freed hostages as to which guard had which nickname.

BuzzFeed News and the Washington Post have spoken to people familiar with the investigation into the identities of the “Beatles”, obtained identity documents, and interviewed neighbours, relatives, and friends to build a picture of the unassuming young man believed to have become one of ISIS’s most feared terrorists.

Kotey, who is half Ghanaian, half Greek Cypriot, grew up in a family of dress cutters in Shepherd’s Bush – just under two miles away from Emwazi – and was an avid supporter of Queens Park Rangers Football Club.

He is said to have converted to Islam, grown a beard, and begun dressing in robes in his early twenties, after falling in love with a Muslim woman. He left two young children in Britain.

Investigators believe Kotey was radicalised while attending the Al-Manaar mosque in Ladbroke Grove alongside Emwazi. Friends have confirmed that he was a regular at the mosque and advocated suicide bombing from a street stall outside.

The mosque leaders said they have clamped down on radicalisation and work closely with the police and the council to combat extremism.

Kotey is also connected to the “London Boys” – a network of extremists who fomented radical Islam while playing five-a-side football in west London and have been linked to the 7/7 London bombings and the subsequent failed 21/7 plot.

Kotey, who is half Ghanaian, half Greek Cypriot, grew up in a family of dress cutters in Shepherd’s Bush and was an avid supporter of Queens Park Rangers Football Club.

Documents obtained by BuzzFeed News have confirmed that Kotey travelled to Gaza alongside Reza Afsharzadegan, a London Boys leader who was close to Emwazi, and two other extremists on the £1 million aid convoy led by Galloway in 2009.

A friend who travelled in the same group says he lost track of Kotey after reaching Gaza and does not know whether he ever returned to Britain – but has since heard that he is in Syria.

A spokesman for Galloway said: “There was, of course, a vetting procedure on those who applied to join the convoy,” and that “the names you have given are unknown to us”.

Investigators believe Kotey travelled to Raqqa, ISIS’s de facto capital, where he is suspected of joining the group of Britons who systematically beheaded and tortured hostages placed under their watch and would become known as the “Beatles”.

The four members of the “Beatles” cell gained a reputation as the cruellest of all ISIS guards, using electric shocks, waterboarding, and mock executions – including a staged crucifixion – to terrorise their hostages. They have beheaded seven British, American, and Japanese hostages and 18 members of the Syrian army.

A group of men look on as a jihadi flag is raised on a building in Raqqa, which would go on to become the de facto ISIS capital. AFP / Getty Images

A Danish hostage, Daniel Rye, who was released in June 2014, recalled in a memoir how “Ringo” had kicked him 25 times in his ribs on his 25th birthday, telling him it was a gift. Rye wrote that “George” dominated the group of jailers and was the most violent and unpredictable.

Rye also recalled being taken to an open grave where a suspected spy was shot by Emwazi on “George”’s instructions while “Ringo” filmed. Rye said the Britons forced him and other hostages to climb into the grave and photographed them.

“Ringo” has stated online that he is “As British as they come”. He also described himself as “born and raised in Shepherd’s Bush, was a big QPR fan, love a good old fry up in the mornings”.

When BuzzFeed News traced Kotey to his family address in Shepherd’s Bush, two garden gnomes wearing Queens Park Rangers football strips outside the front door were the first clue that he might indeed be “Ringo”.

The deeply divided pocket of west London where Kotey grew up has an uncomfortable history as a breeding ground for violent extremism. At least nine jihadis, including Emwazi and the failed 21/7 bombers, were radicalised in the notoriously unequal area, where some of London’s most deprived families live on sprawling estates alongside multimillion-pound mansions, home to super-rich models, footballers, and minor royals.

Alexanda Amon Kotey – known as Alexe to his friends – was born on 13 December 1983 to a Greek Cypriot mother who worked as a printing machinist and a father who hailed from a long line of Ghanaian dress cutters.

Kotey’s mother was just 17 when the couple married, and gave birth to his older brother two months later. Alexe followed four years after that, but the family was struck by tragedy just before his third birthday when his 28-year-old father died of multiple injuries. A relative told BuzzFeed News he had jumped in front of a train.

Kotey’s mother said her son had converted and adopted an Islamic name after falling in love with a Muslim woman.

Neighbours recall Kotey as a “reserved, polite boy” who was a keen supporter of Queens Park Rangers. Kim Everett, who has lived next door to the family for 25 years, remembers Kotey and his brother playing football with her sons in the building’s back garden, and teasing them for supporting Chelsea FC. “I knew him since he was this big,” she said, gesturing downwards. “He grew up with my sons. He was lovely and a really quiet boy.”

Everett said she saw Kotey less often after he moved out of his family home and that she was taken by surprise when she encountered him again when he was about 20 and found he had converted to Islam.

“The next time I saw him he was bearded, full garments,” she said. “I did say to [his mother]: ‘Alexe’s changed his faith?’, and she said yes. She wasn’t too happy.”

Kotey’s mother told Everett her son had converted and adopted an Islamic name after falling in love with a Muslim woman. Everett told BuzzFeed News he went on to marry and then split up with the woman after having two daughters with her, and the relationship was confirmed by his friends.

The children continue to visit their grandmother at the Kotey family home today. Kotey’s mother and brother, who are not being named, refused to talk to reporters from BuzzFeed News and asked that their privacy be respected.

Kotey’s conversion surprised those who knew the family. A man who worked with Kotey’s older brother at a Puma store remembered him visiting the shop.

“I know that Alexe converted to Islam,” he said. “I remember being surprised because [his brother] wasn’t very religious.”

Kotey with his British passport on the “Viva Palestina” aid mission. Supplied to BuzzFeed News

According to friends, Kotey’s faith became more extreme after he began visiting the Al-Manaar mosque, where intelligence agencies believe he and Emwazi were radicalised.

A former friend who also attended the mosque recalls becoming concerned about Kotey’s increasingly radical views. “The guy used to have this stall outside the mosque,” he said, “and those guys used to openly preach and argue about what they thought was their cause or ideology.”

He remembered Kotey debating with a more moderate friend of his outside the mosque: “My friend, now, he would say, ‘You can’t kill yourself, you can’t commit suicide, it’s forbidden in the Qur’an,’ and he [Kotey] would try to justify it, for suicide bombing.”

Adam Nazar, an advisory board member at Al-Manaar, said there had been few controls in place until 2014 when the new leadership at the mosque had “really put a clamp down on everything”. He continued: “The thing with mosques are people can have public conversations in the corner of a mosque and no one would know, that’s the same with a church, that’s the same with a bus station, that’s the same with a college.” He said that under the new leadership, Al-Manaar now ​“has a great relationship with the council, with the police in terms of working around extremism, working with youths, and so forth”.

Dr Abdulkarim Khalil, ​the ​previous leader of the mosque, ​spoke of his difficulties in preventing the radicalisation of young men in the community in a 2014 interview. “We try our best to control what goes on in our premises,” he said. “We don’t allow people to address the congregation; we don’t allow people to distribute literature.

“Unfortunately these things happen on the big occasions, like on Fridays. And then you find people on the street outside the mosque, lobbying people, giving out literature — some of it for good causes, some of it for others.”

Kotey is also said to have fallen in with the London Boys network of extremists in west London, through which intelligence agencies suspect he came into contact with Emwazi’s associate Afsharzadegan. “He’s been known to hang out with that crowd since 2008, maybe even before that,” the friend said.

Despite Kotey’s extremist views, the friend remembers him as being “humble, quiet and reserved”, well-versed in religious literature and shy of being photographed. The man who is suspected of going on to film ISIS executions was in fact so camera-shy that it took his friend hours of searching through his old computer hard drives before two photographs of him were eventually found.

The pictures, which have been verified independently by another friend of Kotey’s, were taken in February 2009 on the controversial “Viva Palestina” aid mission to Gaza, organised by Galloway. The friend who spoke to BuzzFeed News travelled with Kotey on the 5,000-mile journey, along with hundreds of British volunteers carrying a reported £1 million worth of aid to the Palestinian territory in a convoy of 110 vehicles.

The “Viva Palestina” aid convoy of ambulances leaving central London for Gaza in December 2009. AFP / Getty Images

Viva Palestina was beset with controversy when, the day before its departure, nine of the volunteers were arrested under the Terrorism Act by Lancashire police. All were later released without charge, and Galloway branded the move an attempt to “smear and intimidate the Muslim community”.

However, a list of the convoy volunteers obtained by BuzzFeed News reveals that three of the men who travelled alongside Kotey are now known as extremists. Among them was Afsharzadegan, who was in the same sub-group of 25 volunteers. The British-Iranian terror suspect travelled to Somalia in 2006 to be trained by a top al-Qaeda operative, and intelligence agencies believe he was sent back to Britain with instructions to recruit members for al-Qaeda and al-Shabaab.

Despite Kotey’s extremist views, the friend remembers him as being “humble, quiet and reserved”, well-versed in religious literature and shy of being photographed.

Afsharzadegan was a leader of the London Boys network, through which Emwazi is believed to have been radicalised.

Another member of Kotey’s group on the convoy, Amin Addala, has also been named in court as a member of the network. And a third volunteer, Manchester-based Munir Farooqi, was convicted of terror offences in 2011 after attempting to recruit two undercover police officers to join the Taliban in Afghanistan. He was sentenced to life imprisonment.

The friend who travelled in the same group told BuzzFeed News the convoy “changed” Kotey, and he was unsure if he had ever returned to Britain.

Whatever happened on the way to Gaza, the friend said, the true roots of Kotey’s radicalisation lay in the deeply divided area where he grew up. “You grow up with the backdrop and you’ve got a contrast of very rich people like in Chelsea,” he said. “It can make you angry. You feel like it’s an injustice, and so you already feel like an outcast.”

Kotey was connected to the “Beatles” terror cell by the British and American investigators who have been tasked with hunting down the four guards.

Freed hostages have described how the “Beatles” were the the most hated and feared of all the ISIS guards they encountered. Didier François, a French journalist who escaped after being held captive for a year by the terror cell, said they tormented hostages by staging mock executions and telling them every day that they would be beheaded. He also questioned their devotion to Islam, saying they spoke English rather than Arabic and didn’t even have a copy of the Qur’an.

“Jihadi John” was the group’s executioner and staged his killings on video with chilling showmanship while the other members of the cell stood guard. He was responsible for the beheadings of the American journalists James Foley and Steven Sotloff, the British aid workers David Haines and Alan Henning, the American aid worker Peter Kassig, and 18 members of the Syrian armed forces in a period of extraordinary brutality from August 2014 until his death in November 2015. He had previously beheaded two other Syrian soldiers and two Japanese hostages.

Full citations and credit to investigative journalists are here.

What do Banks Say About the Recession?

What do economists have in their forecasts?

It is important to watch other countries performance like China, Greece and Brazil:

Bank Of America Admits The U.S. May Already Be In A Recession

Zerohedge: Almost one year ago, in March 2015, we explained how “The Fed’s Artificial Steepening Of The Yield Curve” has resulted in many unexpected consequences, the most important of which has been the erroneous interpretation of the yield curve as a leading recessionary signal. As said back then, “the artificially steep yield curve is a reflection of policy intent not economic reality…. Where the yield curve in the all-important belly of the 5s10s might have deeply inverted in the past just prior to recession, there is no justification to expect the same attainment of absolute levels where artificial monetary intrusion has pushed the curve much, much steeper.”

One week ago, it was as if a light bulb went off over Wall Street’s head, when first Deutsche Bank’s Dominic Konstam realized the significance of the above excerpt, and admitted that far from the 4% recession odds that the Fed’s hopeless FRB/US DSGE computer model spews out when looking at the “normal” yield curve, when normalizing for the Fed’s intervention odds of a recession in the next 12 months soar to 50%!

In a special report published earlier this week, we noted that today’s near-zero interest rate regime does not allow the yield curve to freely invert or even flatten too much because of certain structural limits. For example, liabilities-driven investors who in the past could receive long rates below the fed funds rate can no longer do so once rates are floored at zero. Investment fund managers are also restricted by mandates from buying negative yielding assets that lead to mark-to-market losses on their portfolios. Pension investors, who must target returns based on liability assumptions, have been driven into high yielding non-core rate assets as their discount rates are stubbornly and unrealistically high compared to Treasury yields. These factors keep the curve artificially steep even though both short and long rates have been clearly trending downward over the years.

An “artificially steep yield curve” – almost as if that’s exactly the phrase we used before. What DB did then is the logical next step: to adjust the artificial yield curve and exclude the Fed’s intervention. 

To address the artificial steepness of the curve we corrected the 3m10y spread for the level of the rates. Specifically we regressed the spread against the short rate, leaving the residual which by definition removes for the bias of the rate level and is centered at zero. Using this new curve as model input, we found the probability of a recession in the next 12 months is 46 percent, considerably higher than the original Fed model has predicted.

But wait, there’s more, because while the short-end remains anchored, with every 25 bps tightening in the 10Y yield, recession odds rise by another 6%.

As it may be useful for investors, we attempt to handicap the relationship between the yield curve and future recessions captured in our model. Holding the 3m rate constant, every 25 bps rally in 10s (implying an equal flattening in 3m10y) raises the recession probability by 6 percent. If 10yr yields rally to 1.50%, our model predicts a 59 percent chance of recession in the next 12 months; at 1.00% 10s, the probability is 71 percent.

 

At Friday’s close, recession odds are well over 50% according to DB’s model.

Or perhaps far higher, because shortly after DB admitted what we said in early 2015, namely that everyone who was looking at the yield curve as is was wrong, Bank of America’s Ruslan Bikbov did the exact same analysis and ended up with a far more disturbing conclusion:

The US Treasury curve is still steep by historical standards. Taken at face value, this may suggest recession odds are small. However, we argue this logic is flawed because the curve is structurally steep when the Fed Funds rate is close to zero. When adjusted for the proximity of rates to zero, the curve may already be inverted and therefore may already be priced for a recession.

And numerically: “Implied recession odds are as high as 64% if the adjusted OIS curve is used

Laughably, this comes from the same bank whose chief economist Ethan Harris recently “predicted” US GDP for the next decade and forecast there will be no recession until 2027… the same Ethan Harris as profiled in “Perma-bears” 1 – BofA Economist 0.

* * *

Below are the full wonkish details from BofA for all those Wall Street strategists who still hold on to the erroneous creed that recession odds are non-existent if simply looking at the unadjusted yield curve.

A leading recession indicator

We received numerous questions on the shape of the US yield curve and its relationship to recession odds. With the sharp weakening of US manufacturing data in recent months, recession risks are on everybody’s mind, while the curve has the reputation of one of the most powerful leading recession indicators. The basic fact is likely well known to our clients: each US recession since the mid 1950s (when Treasury bond data become available) was preceded by an inverted or extremely flat curve within one year before a recession start (Chart 8). This is, of course, intuitive because a flat curve reflects lower growth and/or inflation expectations. Some of our clients and market commentators pointed to this fact and the relative steepness of the curve to argue that current recession risks are rather low. Indeed, the 3m10s curve at 155bp is still far from being flat (Chart 8).

Mind the zero bound

However, we believe that a simple mechanical extrapolation of the past link between the curve and recession odds is flawed. In particular, curve-based models calibrated to pre-2009 data are likely to underestimate recession odds today. This is because with the Fed Funds at only 38bp risks for plausible Fed Funds paths are asymmetric. Although tighter policy paths are unconstrained, the room for further cuts is likely limited resulting in a steepening bias for the curve. To see this, imagine an extreme situation where the policy rate is at zero and negative rates are not feasible. In such a scenario the curve simply cannot invert, and must be necessarily biased steeper relative to its historical distribution.

Granted, we cannot rule out the possibility of negative rates in the US, but it is safe to say the Fed’s reaction function must be highly asymmetric around zero. Because negative rates entail significant risks for the financial stability of money market funds and the banking sector, the negative growth/inflation shock required for a cut below zero should be larger than positive shocks required for a hike of a comparable size. In addition, negative rates should be floored by the storage cost of currency, another reason for asymmetric risks around zero. In any case, the market currently sees only a small chance of negative rates in the US (Chart 9). The end result is structural steepness of the curve at near-zero Fed Funds levels.

Don’t wait for the curve to invert

Even a casual look at other countries with near-zero policy rates confirms that the curve does not need to flatten significantly for a recession to occur. Consider Japan, a country with the longest zero-rate history. Japan had a recession in 1991-1993, which was preceded by an inverted curve, consistent with past US experience (Chart 10). But note the call rate was at 8% when the curve inverted. Since 1995, the call rate has not exceeded 50bp. Over that period, Japan had four official (announced by the Committee for Business Cycle Indicators) recessions, none of which was preceded by an inverted curve (Chart 10).

A number of other G10 countries adopted near-zero rate policy regimes since 2008 and experienced recessions since then. Some of these recession episodes are analyzed in Table 3. We use two methods to identify recessions: technical definition (at least two consecutive quarters of negative growth) and recession dates reported by Economic Cycle Research Institute (ECRI), which employs methodology similar to that of the NBER in the US. For each recession episode, we report the range of the 3m10s government curve and the policy rate observed for a year immediately before the beginning of a recession.

Again, an inverted curve did not emerge to signal an imminent recession. In fact, in some cases the curve ahead of recessions was steeper than in the US today. As an illustration, Chart 11 shows the historical German curve. Consistent with typical US experience, the curve flattened to extreme levels ahead of each of the pre-2009 recessions. However, Germany also had a technical recession in Q4 2012-Q1 2013 when the ECB rate depo rate was at zero. Not surprisingly, the curve remained steep before that recession. In fact, the curve did not flatten below 120bp in the one-year period ahead of the recession.

Adjusting the curve for zero-rate effects

Although the curve cannot be taken at face value in a near-zero rate regime, we believe it may still provide useful information about recession odds if adjusted for the zero bound effect. The idea is to estimate a model-implied curve that could be prevalent today if negative rates were just as feasible as positive. The curve adjusted in such a way may be directly compared to its historical distribution. As a result, it may be a better recession signal than the observed curve.

Turning to technical details, we model forward rates with a truncated (at zero) normal distribution, calibrated by matching its mean and standard deviation to forward rates and at-the-money option prices. We then compute adjusted forwards as the mean of the corresponding distribution without truncation (hence, using a symmetric distribution around the mean and allowing for negative rates). Although the choice of the truncated normal distribution is somewhat arbitrary, it provides a simple tool to model the core of our argument. Because very long-dated options are not liquid, we analyze 3m5s rather than 3m10s (normally used in academic literature) Treasury curve for this analysis. We found only a small deterioration in R2 statistics for recession forecasting probit models when the 3m5s curve is used instead of 3m10s. Consistent with intuition, the 3m5s curve adjusted in such a way has been significantly flatter than actually observed curve (Chart 12).

Technical factors contributed to Treasury curve steepness

Further, the Treasury curve may be currently skewed steeper by technical factors. Treasury bonds in the belly of the curve dramatically cheapened in the past few months, which is evident from extremely tight levels of swap and OIS/Treasury spreads. As a result, the Treasury curve now looks very steep to OIS. While the 3m5s Treasury curve is at 92bp, the corresponding OIS curve is only at 56bp (Chart 13). The likely reason for this is reserve selling of foreign central banks who need to support national currencies against the recent USD appreciation. International reserves of world central banks declined by about $1tn since September 2015. At the same time, the ability of dealers to absorb the supply has declined in recent years due to regulatory pressures on balance sheets.

Conventionally, academic literature on recession forecasting uses Treasury curve data. But the Treasury curve may not be the best measure of market expectations, presumably the key component of the curve predictive power. Because of the technical nature of the recent Treasury cheapening, the OIS curve should be a better measure of market expectations, and therefore may be more relevant for  assessing recession risks.

 

The curve may be priced for a recession

Applying our methodology to the OIS curve, we found that the adjusted 3m5s OIS curve at -30bp is already inverted. This suggests that the curve already could be priced for a recession (Chart 12). Granted, our methodology signaled a false alarm in 2012 when the curve was also inverted but a recession did not follow (Chart 12). However, at that time the curve flattened to extreme levels because of the forward guidance, an unprecedented event in the history of US monetary policy. In contrast, this time the curve flattened following the Fed hike, which looks more like a typical curve inversion episode. In fact, the Fed was hiking in all previous historical episodes where the curve inverted ahead of US recessions (Chart 8). From this point of view, the current curve flattening may be more worrisome.

Implied recession odds

Our economics team sees only about a 20% probability of a recession in the next year. They argue that the two most important causal factors in recession–aggressive Fed tightening in a battle against above-target inflation and very high oil prices–are not evident today. They also argue that both “real” and financial bubbles are small. The only sector that overexpanded in the recovery is the tiny oil and gas sector (about 2% of the economy at the peak) and the high yield sector overshot fundamentals, but it is much less important than the housing and equity market bubbles of the last two cycles.

Nonetheless, clearly markets are worried and an indicator we have developed confirms their concerns. To quantify implications from the inversion of the adjusted curve, we follow academic literature to compute model-implied recession probabilities from a standard probit regression based on the curve. We acknowledge this type of a model is highly simplistic and does not take into account all the complexities of today economic environment. Still, model probabilities may be interesting to know given the curve’s track record.

We estimated a standard probit model to pre-2009 sample when zero rates were not an issue. We then computed implied probability of a recession within next 12 months with different assumptions about the proper curve to be used in the current regime (Table 4). The model implies about 32% recession odds if the Treasury curve is taken at face value. Just using OIS instead of Treasury rates brings this probability to about 42%. Implied recession odds are as high as 64% if the adjusted OIS curve is used (Table 4).