Albert Edwards at Societe General brings the sense as usual.
US recession looks imminent and the discussion in the markets has moved on to how deep it will be. Forecasts for a ‘mild’ recession will now abound. But when a key Fed economic model sees an 80% chance of a hard landing, you know things are bad!
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The media refers to me now as a“market veteran”. That is code for the fact that I have been knocking around the markets now for a very long time–40 years. One of the perks of being a market veteran is that my long-term memory improves with age (or at least I believe it does) inversely to my short-term memory deterioration. So once again as recession and market meltdown looms, familiar phrases are returning to greet me like long-lost friends. But their return doesn’t bring much comfort. Instead, they ring alarm bells.
Indeed it was only recently that we heard the Fed’s familiar, end-of-cycle dismissal of the inversion of the 2y-10y part of the yield curve as a recession predictor.
And I’ve read with increasing regularity that equities have fallen so quickly, well ahead of profits, that “equities have already factored in a recession”. Another alarm bell just rang!
There really is no pretence now that the Fed has, in an act of penance for allowing inflation to get out of control, donned a horse-hair shirt and is fully prepared to drive the US economy into recession. Powell talking about a “softish landing” was as explicit an admission of recessionary intent that I can recall from a Fed chair.
Market commentators are now determinedly saying that the recession (which they never forecast in the first place) will be shallow. That is again a normal spurious landmark we pass at this stage in the cycle before all hell breaks loose and boththe economy and markets collapse.
Perhaps the more interesting question is not how deep the recession will be, but how large the fall in yields will be? The recent inflation surge broke the close link between the real economy data and bond yields (see chart below). Will a recession dispel inflation fears (temporarily) and drive bond yields substantially lower? The outlook for commodities is key, especially with the backdrop of the war in Ukraine. But I still see commodity prices plunging just like in Q4 2008, back then taking headline CPI inflation from +5% to-2% in just 12 months. Could we see sub-1% 10y yields once again? Now that would be one heck of a surprise.
Global Strategy Weekly222 June 2022Signs of a US recession are mounting almost daily. It’s not just that the ‘here and nowcast’ for Q2GDP from the Atlanta Fed stands at zero (after-1.5% in Q1). The leading indicators look grim as well. For example, the Conference Board leading indicator fell for the third month in a row in May and that now makes 4 declines in the last 5 months. That is normally the stuff of recession, and indeed the 3-month % change recently fell the most since the last recession (red line in chart below), although to be fair the 6-month % change (which the Conference Board itself says is the best predictor of recession) is not yet quite below its 2016 low (dotted line in chart below).
But even taking the slightly less bearish 6m % change in the leading indicator suggests the manufacturing ISM is set to now slump by about 10pp very quickly indeed.
That pace of decline in the ISM, one of the most high-profile economic data points, certainly tallies with a recent forecast from one of the NY Fed’s own economic models of recession.
Although a ½% GDP decline doesn’t seem particularly punchy, it is quite shocking to see that in only 3 months the NY Fed model has chopped 1½% off its GDPforecast for both this year and next! In addition, the length of predicted recession-two full years-is extraordinary. Add to that probably the most bearish comment I have ever heard from a Fed bank–“the odds of a hard landing are around 80%” and wow! Among the great work I like to read each week is the @Callum_Thomas weekly Chart Storm (available on Substack and Twitter). This week he notes [email protected], head of Market Strategy at Nordea, was flagging that “The problem with (current)lower P/E ratios is that while the P has moved, the E is on thin ice–and the cracks are starting to show…”–see chart below.
Let’s assume-plausibly-for a moment that the US economy does suffer a hard landing and the S&P collapse resumes apace. It goes without saying then that at some point rising unemployment and chaos in the markets will force the Fed to capitulate, or as they will euphemistically call it, pause their tightening cycle! And then the next step as the economy collapses will be to slash rates back to zero and resume QE. We have been on this trip before, and we know what happens.
The counterargument to this is that the Fed will stay the tightening course because of sky high inflation. And they may do so for a short while, but what if headline inflation collapses?
Commodity prices are already clearly rolling over (see left-hand chart below) with oil and agricultural prices slower to decline. That is likely partly due to the war in Ukraine, but we saw a similar slower cyclical response from oil and agricultural prices in 2008 H2 (right-hand chart). Meanwhile the UBS industrial metals index is some 30%off its March high and copper is down 20% (see chart). If (when) the oil and agricultural complex joins this bear market, headline CPI inflation could quickly collapse to below zero just as it did in 2008/9 when headline CPI fell from+5% to-2% in just 12 months. A similar fall into negative inflation would likely take bond yields substantially lower, even if core CPI stays sticky above 2%. Although a sub-1% 10y yield seems to me entirely plausible, I suspect we won’t now see a fall below the March 2020 0.3% low as the secular Ice Age trend of lower lows and lower highs in each cycle is broken. The new secular trend may now be for higher inflation and higher yields, but a cyclical recessionary shock awaits.