Articles by Chun Wang Director of Multi-Asset Strategies

Our recession indicators have continued to deteriorate. Given the stagflation backdrop, the Fed’s tightening cycle is very likely to end in a recession.

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The risk of a policy error is extremely high as the Fed stays on an aggressive tightening path even with the U.S. in a “technical” recession. Caution is recommended.

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Our recession indicators have continued to deteriorate. Given the stagflation backdrop, the Fed’s tightening cycle is very likely to end in a recession.

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Now that the yield curve has inverted, its dynamic is apt to change from bear flattening (higher rates, flatter curves) to bull steepening (lower rates, steeper curves) fairly soon.

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While the non-seasonally adjusted headline CPI  made a new cycle high with a 9.1% year/year print, which is also the highest since 1981, the Core CPI continues to ease. 

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The risk of a policy error is elevated as the Fed stays on an aggressive tightening path even though growth materially slows. Caution is recommended.

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The late 2018 policy error and subsequent pivot of Chairman Powell’s rookie year is probably the best case-study for today’s pivot debate. Here we evaluate the current status of key pivot triggers and compare them to the readings of late 2018. Given the political environment and backward-looking nature of the Fed, we think the bar is higher for a pivot than the market hopes.

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We have seen the high in bond yields this year and expect a volatile grind lower in rates over the summer: Bearish Treasury positions remain significant, the Copper/Gold ratio fell sharply, and the Citi Economic Surprise Index implies more downside.

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While inflation might have peaked, a material slowdown looks more certain as the Fed stays on an aggressive tightening path. Caution is warranted.

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Overall, there are now more warning signs, but it still doesn’t suggest a recession is imminent.

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Intuitively, what happens in the credit market is usually echoed by lending activities. This was a key concern when the credit market joined the stock-market rout in May. Another big leg up in real interest costs, through higher rates and/or lower growth, will surely create more headwinds for profit margins.

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The CPI numbers were hotter than expected. Our Scorecard still suggests cost-push inflation continues to have an upper hand in driving inflation higher, an unfavorable scenario for risky assets.

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As long as the Fed stays on the current aggressive tightening path, caution is highly recommended.

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Most U.S. dollar drivers point to a stronger dollar: attractiveness of U.S. assets; policy differentials; real interest-rate differentials; terms of trade; weaker Yuan; and capital flows/hedging activity. Speculative positioning, however, is a negative and suggests the dollar rally might at least take a pause in the near term.

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The CPI numbers are largely in line. Our Scorecard still suggests high inflation pressure for now, but there are indications that inflation has probably reached a medium-term peak and the pricing for Fed rate hikes will likely come down.

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With the Fed still on a tightening path, caution is still recommended. Among fixed income, we remain neutral on TIPS but have turned favorable toward EM bonds.

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Currently, the dashboard shows 6 green, 3 yellow, and 2 red lights. The overall message is that, while there are areas of concern, a recession is unlikely to be imminent (within the next twelve months).

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Predicting a recession is a very tall task, let alone using a single yield-curve indicator with long and highly variable lead time. Instead, we would rather focus on some of the more reliable themes: The macro-policy setting; U.S. dollar; and Bank stocks.

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Despite continued weakness in equities and a higher reading in our Risk Aversion Index (RAI), it generated a “Lower-Risk” signal.

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The U.S. 10/2-year curve just fell below the key threshold of 50 bps. Over the last 25 years, the yield curve proceeded to invert after this “Rubicon” was crossed. That doesn’t mean imminent trouble. The lead time of a yield-curve signal is lengthy, but it—and real yields—definitely warrant close monitoring.

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