Murmurs Of Recession

It’s not all bad news, believe it or not.

Well, it really is. But we can pretend.

Weary market participants were handed a reprieve this week, as stocks rallied for four consecutive sessions, despite a hawkish Fed and the ongoing tragedy in Ukraine, where the Russian military machine continued to wreak havoc, albeit while stymied in several key locales by a determined resistance.

The consensus among analysts is that the nascent bounce was little more than a positioning-driven bear market rally, but one of those analysts also outlined what he called “bull drivers or catalysts for bear rallies outside positioning.”

In his latest, BofA’s Michael Hartnett cited Beijing’s dramatic verbal intervention this week, which catalyzed a spectacular two-day surge, the likes of which are essentially unthinkable for developed market benchmarks (the Hang Seng Tech Index rose 22% in a single session).

If Beijing follows through on pledges to support markets and the economy, it could “end China GDP growth downgrades [and] put a floor in for global GDP estimates, as well as lowering geopolitical risk from China-Taiwan,” Hartnett said.

In addition, any further declines in oil prices would likely be predicated on a Ukraine ceasefire, and that, in turn, could mean “peak inflation,” according to BofA. They suggested it’s possible the new Fed dots (which tipped an eventual move into restrictive policy) mark “peak rates shock” which, if true, would mean “peak US dollar, peak bank stocks [and] back to the cherished old playbook of long tech.”

To be clear, that’s not Hartnett’s base case. He’s still of the view that the “rates shock” and the “inflation shock” have further to run, and that the back half of the year is likely to see a “recession shock,” if not an actual recession.

Friday brought more hawkish Fed banter as Jim Bullard called for the equivalent of a dozen 25bps hikes in 2022, and a poor read on the housing market, where existing home sales plunged more than 7%, to a below-consensus 6.02 million annual rate (figure below).

While nothing to panic about, the housing data perhaps suggested sky-high prices and rising mortgage rates are starting to erode demand.

“Housing affordability continues to be a major challenge, as buyers are getting a double whammy: Rising mortgage rates and sustained price increases,” Lawrence Yun, NAR’s chief economist, said, in a press release. “Some who had previously qualified at a 3% mortgage rate are no longer able to buy at the 4% rate,” he added. Monthly payments are up by nearly a third from a year ago.

“This is to be expected and we’re skeptical [it’s] an indicator of a truly significant correction looming” in housing, BMO’s Ian Lyngen remarked on Friday. “Nonetheless, it is difficult to expect real estate to perform in 2022 as it did earlier in the pandemic.”

Indeed. And that speaks to the real problem right now. Even if you see catalysts for bear market rallies or are predisposed to some version of the “soft landing” narrative, it’s virtually impossible to imagine risk assets performing strongly considering the backdrop. There’s a compelling bear case for nearly everything, from equities to bonds to credit.

Take US IG, for example. Blue-chip corporate bonds are on pace for their worst quarter since 2008 (global IG is -8%), as inflation argues for higher rates. Although equity flows picked back up last week, credit flows are still foreboding. Consider the figure (below).

Credit outflows have accelerated materially. IG funds bled another $3.1 billion over the latest reporting period, according to Lipper. That came on the heels of a $5.36 billion exodus the prior week, the most since the early days of the pandemic.

EPFR’s data showed a 10th straight week of outflows for credit funds, with the pace accelerating to more than $13 billion on a four-week average basis. That’s trouble. The IG outflows are a response to higher rates, while the bleeding in high yield is indicative of risk-off sentiment. Total credit outflows in 2022 are now near $110 billion. That compares very unfavorably to $82 billion of inflows during the same period last year.

Emerging market debt has seen outflows for 10 consecutive weeks. EM debt enjoyed around $30 billion of inflows in 2021. Half of that has come back out already this year.

Writing Friday, Nomura’s Charlie McElligott said that in his view, the mechanical rally “is now likely to face upside constraints, so it feels like a ‘short (hard) delta’ trade again into the coming FCI tightening surge from central banks, as balance sheet runoff joins hiking as well as mounting recession concerns.”

BBG

We’re entering “the peak risk window” for upside inflation overshoots, he went on to write, noting that the prospect of more upside surprises in price gauges “means the window for imminent ‘peak hawk’ posturing from the Fed” is also open.

Markets are now convinced of a policy mistake or, at the least, an about-face (figure above).

In the same note, McElligott described “murmurs of recession.” The market is “increasingly pricing a hard landing,” he said. “Which means Fed easing being pulled forward.”


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7 thoughts on “Murmurs Of Recession

  1. I’ll jump on the bandwagon and then on a soapbox to make the case that long-term GDP stagnation wasn’t solved by trumps campaign promises – and that as we drift into the post pandemic global reactions to COVID and Ukraine, things haven’t improved at all. The V recovery will result in less employment, less growth and fewer opportunities in general.

    The theme that was evolving a week ago was related to stagflation, which bounces between deflation and inflation. In this whipsaw environment of polarized thinking, it makes sense that we’ll experience a nice mixture of extreme volatility in our global economies. Slow, stagnation will be offset by speculative excess and the ongoing reality of systemic decline and social decay.

    Real GDP pairs nicely with simple things like median household income or wages or investments in our broken world.

    Perhaps the reason behind the rumblings of recession is the fact that the pandemic recession was sidestepped and swept under a global rug.

  2. 2022 is going to be a tough year there is no argument about that- both in the markets and in the real world. Even if Ukraine fighting stops and the pandemic diminishes, we all have a bucketload of problems to solve. Even if the market goes up, it is clearly not going to be a smooth ride- and it will be lucky to be a plus to any great degree. The real question is what is the world going to look like heading into 2023 after the US midterms, Ukraine sorting out and a new covid season beckoning in the fall? If things don’t completely go off the rails in 2022-23 the world has a real chance at a reset going into 2024. But a whole set of problems have to go right, and new ones need to take a breather….But looking back at what the US/Great Britain and the rest of the world has gone through makes me feel that somehow we will muddle through. Investors don’t sell everything- make sure you can ride out the next 18 months and things will likely look better after that…..

  3. It is great to only have to be worried about “first world” problems.
    For those of us living in the US- let us not forget, we won the lottery.

  4. “End of war means commodity price relief” sounds like “end of war means end of sanctions”. I think more likely is that sanctions on Russia (and Belarus) continue after the war, and de-globalization gathers pace, supporting commodity prices for some longer period. Until demand destruction, supply response, or market dysfunction brings them down.

    More broadly:

    We were headed to a significant slowdown in 2022 even before Russia invaded Ukraine. You don’t take away $4TR fiscal and $4TR monetary stimulus without consequences. The post-Covid reopening was expected to be strong enough that economic growth, though slowing, would stay positive and avoid a recession. That backdrop implied a “mid-cycle market correction into a later phase economic cycle” sort of period for stocks, probably larger than normal since stocks ran so furiously in the early phase.

    Now add higher commodity and supply chain costs, higher defense spending, higher inflation, and higher geopolitical risk (China -> Taiwan & US at war in the South China Sea now looks not unthinkable, and Putin will more than ever need something to distract from domestic woes). Throw in China’s multiple “own goals” and maybe another Covid surge. Its is hard to see why the 2022 outlook has improved, and easy to see why it has worsened.

    Will we still avoid a recession? The forecasters will disagree as usual. One of the best forecasters, with the best track record, is the yield curve.

    If the 2Y-10Y inverts, then it’s best to position for a high probability of recession. Sure, it can always be “different this time”. But that’s a low probability bet. Investing is a game of probabilities, not heroics. When the curve inverts, be defensive and wait to see what happens.

    1. Should the yield curve give us better signals, going forward, now that the Fed is back out of the fixed income markets? I would think so (…although ECB and Japan are still in theirs, and some of that ongoing distortion probably still trickles through to the US bond markets)

  5. H-Man., so is there any good news out there to support what happened this week in equities? It seems like a giant dead cat bounce but at the end of the day, a dead cat bounce.

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