Fatalism pervades much of the macro commentary, and you don’t need to listen too closely to hear it.
You can blame the curve. As a recession indicator, it boasts a far better track record than any economist. Economists know that, and while they begrudge the bond market a prescience that eludes complex models and the PhDs who employ them, they’re reluctant to ignore the signal.
Unfortunately, that signal admits of little ambiguity. The entire curve has a date with inversion. If your preferred section isn’t already inverted, you won’t have to wait long. A simple interpretation of the figure (below) is that the die is cast. The clock has started. Recession is coming.
Of course, there are any number of plausible counterarguments for why this time is different. QE distorted many bond market signals and beyond that, extreme ambiguity about the long run means it’s now far easier to bet on the next Fed meeting than it is to venture a long-term macro forecast. That conjuncture is a flattener as long as inflation continues to run hot. The presence of a commodities shock and the prospect of a haven bid for the US long-end amid war escalations complicates things further.
But many market participants view the nuance as a distraction. The curve has spoken, they’ll say. Hence the palpable air of fatalism mentioned here at the outset.
“This time is different. The rules have changed, at least to some degree,” Morgan Stanley’s Seth Carpenter wrote Sunday, after explaining why, in his view, we’re not “replaying the 1970s,” even as “the Fed’s challenge is clear.”
Some things, Carpenter went on to say, haven’t changed, though. “As usual, the curve has flattened with this hiking cycle [and] with the Fed set to hike into restrictive territory, [it] will invert,” he sighed.
The bank’s Guneet Dhingra now sees a “full inversion” in the second quarter, and while Mike Wilson (Morgan’s well known chief US equities strategist) said there’s no guarantee of a recession, he now sees multiples undershooting his 18x P/E target by more than he originally expected.
Although Wilson suggested the rally seen over the past two weeks may have some room to extend, he’s steadfast in the conviction that stocks are in a bear market, and investors would do well to view fleeting strength as an opportunity to position themselves defensively.
“As has always been the case in the past, markets will debate whether an inversion presages a recession,” Carpenter remarked, in the same Sunday note cited above. He conceded that a policy mistake which triggers a downturn “is clearly possible,” but said the bank’s baseline case calls for “an inversion without a recession.”
Of course, we’ve all heard that before. And Carpenter seemed acutely aware that some market participants are inclined to cast a wary eye at the notion that a whole-curve inversion wouldn’t presage a recession. But it is what it is. As he put it, “the more things change, the more they stay the same.”
I suggest we have a broken recession clock or for the time being a Schrodinger timepiece that exhibits simultaneous kitty litter boxes which are suspended in time, perhaps space as well.
Mishkin at the Fed, said in 1998 the best gauge for leading edge recession stuff is the 10 year 90 day spread, which right now, says everything is wonderful, however, the 10 year 2 year spread is saying hold onto your ankles.
Nonetheless, mishkin also suggested that in addition to the spread it’s useful to look at money supply, which has had it’s own run-in with pandemic craziness.
If you will permit a Fred link, this problem be shown below:
https://fred.stlouisfed.org/graph/?g=Nt7x
One possible problem with the recession clock may be related to monetary base stuff. The prior link shows the divergent directions of curve dynamics, but both are linked to overall money supply and monetary base activity.
I have a smartphone, so can’t adjust axis stuff for these charts, but, the pandemic has certainly changed the base, as can be seen below.
I image the Fed is in an impossible situation to be able to forecast the proper trends. It seems likely that they’ll be arsonists and burn up money asap. I guess the next test for repairing this clock is to understand what happens after the base is adjusted?
https://fred.stlouisfed.org/graph/?g=Ntfx
One more timely post then I’m done. This is from a Barron s article from about a week ago, kinda fits right in:
“Going back to the post-WWII era, Minerd says the monetary policy takeaway from the 1946-48 episode is that much of the supply-demand imbalance was caused by the virtual cessation of production of consumer durables, not unlike what happened at the onset of the pandemic. About a year after the war ended, the consumer price index was running at a 3.1% year-over-year rate and peaked 9 months later at 20.1%. He says that spike followed a period of explosive growth in the monetary base—essentially all currency in circulation and on bank balance sheets—as well as rapid growth in the Fed’s balance sheet, which grew 300% from $6.2 billion in 1942 to $24.5 billion in 1945. (Since the start of the pandemic, the amount of securities on the Fed’s balance sheet has grown 100%.)”
USD swap and OIS curves are even more inverted than UST spreads right now, which are arguably better indicators of recession and the rapid tightening of credit