Paul Revere And The Recession Narrative

In Q4, the narrative was that you should sell stocks because a recession is coming and the Fed was inexplicably inclined to act as a cruel enabler, hell-bent on hiking the economy into a slowdown. Amusingly, some of the same people complaining about the deleterious side effects for risk assets of the Fed’s masochistic tendencies, were celebrating Jerome Powell’s penchant for restoring discipline to a world hooked on monetary heroin.

In January, the narrative was that you should buy stocks because even if a recession is coming, the Fed was inclined to bail out your portfolio with a decisively dovish pivot designed to support stocks and other risk assets. Of course, the people castigating Jerome Powell for “capitulating“, being “pathetic” and/or “embarrassing” weren’t generally inclined to forgo the gains in their portfolios catalyzed by the Fed’s historic “blink“. Imagine that.

In any case, the recession story never really faded amid the best start to a year for stocks since 1987. If anything, the downturn narrative gathered steam in January even as 98% of global assets posted positive total returns as the Fed’s relent served to “validate” some market participants’ worst fears – that is, surely Powell wouldn’t be leaning this far to the dovish side if he weren’t concerned.

Indeed, one analyst we spoke to a day after the January Fed meeting suggested some folks believe the Fed may be trying to get out ahead of something foreboding. “Fed talk revolving around the fear that Powell knows something bad nobody else knows, like China’s gonna be a sh*tshow, so this could be preemptive to offset a blow”, that person said.

The latest edition of BofAML’s rates and FX survey (out Friday) shows a rather dramatic (albeit unsurprising considering Fedspeak and the January statement) uptick in the percentage of respondents who expect caution from the Fed. Generally speaking, most participants in the bank’s poll think Powell will support the economy, thereby obviating the need for a cut in 2020. That said, the percentage of respondents who believe the Fed will not be able to raise rates again in 2019 and will be forced to ease next year more than doubled from the January survey.

(BofAML)

Perhaps the most entertaining thing about that visual is that the percentage of respondents who admit they “don’t know” what the Fed is likely to do next dropped to zero in the February survey. If the success of forward guidance is measured by the extent to which market participants feel like they have some claim on an opinion, well then consider this Fed “successful.”

Meanwhile, Barclays was out pseudo-mocking the recession narrative (albeit with a hint of caution to acknowledge that a downturn is indeed possible) in an update on the bank’s expectations for the Fed in light of the dovish pivot. To wit, from a note dated Thursday:

“The recession is coming, the recession is coming!” Just as Paul Revere and the Sons of Liberty rode throughout New England to warn inhabitants about the coming British invasion, the slowing of growth in economic activity and changes in important financial variables could be warning signs of an impending recession later this year. We do not agree with this as a baseline outlook for the US economy, particularly in light of labor market strength, but financial markets think differently and there is evidence that bank lending standards continue to tighten.

Assuming the downturn does materialize, Barclays notes that “understanding the course of monetary policy is fairly straightforward since Fed communication in this area has been clear.”

If there’s a marked deceleration in the data that suggests the outlook has deteriorated to the point that a recession is any semblance of likely, it “would cause the Fed to stop the balance sheet runoff and begin rate cuts [and] if the downturn was severe enough to warrant more easing than the zero-lower bound permits, then the committee would turn to unconventional balance sheet policies as a supplement”, the bank writes, in the same note.

Meanwhile, Deutsche Bank’s Aleksandar Kocic is out with a short piece, featuring some quick thoughts on all of the above.

“Although in the first hours after the FOMC meeting the surprisingly dovish outcome triggered a wide range of interpretations, it was quickly recognized as a logical response to global economic slowdown and the effects of the Fed’s double-dial tightening”, he writes, adding that “in that environment, overly tight monetary policy, and strong USD that comes with it, would amount to importing disinflation [so] backing away from what the market perceived as an overly hawkish stance underscored the Fed’s awareness of the underlying economic factors and the adaptability to the current market configuration.”

Kocic goes on to note that recessions generally result from forced deleveraging due to surging inflation or clear imbalances in the economy, neither of which are readily apparent at the current juncture. Obviously, the Fed is leaning on subdued inflation to justify the inclination towards “patience.” Here’s a bit more from Kocic:

Current pricing exaggerates the risk of recession. This does not mean that this risk is nonexistent, just that the markets are overpricing its likelihood. There is a sense of fragile local stability overlaid with elevated premia associated with tail risk.

In any event, you can write your narrative.

As mentioned here early Saturday (and on any number of occasions in December), it’s important to remember that fear-based narratives are not necessarily indicative of deep understanding, or inside knowledge. If you find yourself a Michael Burry, by all means hand him your nest egg, but be wary of bloggers and Twitter personalities professing to “know” things that everyone else doesn’t.

To be clear, the doomsday crowd may well be right to suggest that a recession is imminent. But that would hardly make them Nostradamus.

After all, it doesn’t take a Michael Burry to predict that this expansion is likely on its last legs…

(BofAML)