US Recession: ‘Soooo Consensus’

A trying week for markets and the international community ended with more bloodshed in Ukraine and losses on Wall Street, where US shares snapped a three-week win streak amid a cacophony of hawkish Fed banter.

Consensus is now coalescing around the inevitability of a recession in the world’s largest economy. It’ll be a while before analysts adopt a downturn as their base case, but that’s certainly the direction of travel. Bill Dudley darkened investors’ doorstep again with another dour Bloomberg Op-Ed, in which he suggested his former colleagues (at the Fed, not at Goldman) may need to “force” stocks lower. Late last month, Dudley said a recession is a foregone conclusion.

Larry Summers who, like Dudley, found a home at Bloomberg opining on how poorly the people currently doing the job he once did poorly are performing, described “a very difficult set of challenges.” “Recession in the next couple of years is clearly more likely than not,” he told a kindly mannequin called David. “I suspect that’s how the consensus will evolve,” Summers added.

On this point, at least, I’d have to agree with Summers. Indeed, consensus is already “evolving” among investors with enough AUM to be paraphrased in sellside research. “Bill Dudley is in everyone’s mind right now,” BofA’s Michael Hartnett said, loosely quoting feedback from conversations with clients. Other soundbites included “No one wants to get cocky ahead of 50bps and QT,” “Can’t make my mind up if it’s recession or stagflation” and “Recession now soooo consensus.”

The “soooo” suggests clients are exhausted by recession prophesying and curve inversion talk. Morgan Stanley’s Andrew Sheets recently offered a similar assessment. “Most of my meetings this week focused on yield curve inversion, a sign that the topic is either top-of-mind or so widely discussed that everyone is tired of talking about it. Or maybe both,” he said, quoting a Morgan client as follows: “We’re very focused on curve inversion and very tired of talking about it.”

When it comes to the curve, it’s not the inversion you should fear, but the re-steepening. Generally speaking, that takes a while, but this is a cycle in which everything has happened at warp speed — the bear market, the recession, the bull market and the rebound all played out in record time. So, why not the re-steepening?

The figure (below) shows the 2s10s and 5s30s poking back into positive territory, albeit with caveats. “Despite a resumption of post-FOMC minutes steepening, forward curves continue to forecast deep inversions, notably in the 2s10s,” Bloomberg’s Edward Bolingbroke wrote Friday.

“As 2s10s has pulled back from inversion, zero once again is consequential for support and the new flat mark is -9.5bps that represented the depths of the latest inversion,” BMO’s Ian Lyngen and Ben Jeffery said. “A volume bulge around 20bps is steepening resistance, and overhead is the 50-day moving average at 32bps.”

Obviously, the Fed isn’t going to blink anytime soon. The March minutes made that clear enough, as did the bevy of speakers market participants heard from throughout the week. Balance sheet runoff will commence next month, likely alongside a 50bps hike.

I spent a good portion of the week reiterating that, in my view, it’s highly unlikely the Committee can match market pricing for 250bps of outright hikes this year atop 200bps in tightening already “in the market,” so to speak, from the rise in the shadow rate off cycle lows, with aggressive QT as the cherry on the sundae. The cumulative tightening impulse would doubtlessly undercut equities and push credit spreads wider, which would only add to the tightening impulse.

“I don’t believe the recent ‘micro’ yield curve steepening is ‘the’ move yet. It’s more reflective of difficulty carrying crowded flatteners,” Nomura’s Charlie McElligott wrote Friday. Still, he emphasized the same “fear the re-steepening” point mentioned above (and illustrated below).

“This pivot from bear flattening inversion into steepening tells you that the market has ‘smelled the recession,'” McElligott said, before reiterating that “the recent steepening was more about… profit taking and unwinding” in crowded flatteners.

In other words, this probably isn’t the steepener you’re looking for. That comes later. Or who knows, maybe it comes now. Because, again, everything is faster this cycle.

Ultimately, the curve may be ancillary. “Setting aside any perceived correlation between the shape of the yield curve and the probability of a recession, the reality remains that the Fed is removing a massive amount of stimulus during a crucial stage in the recovery,” BMO’s Lyngen remarked. That, he said, raises “the question whether US growth can retain positive momentum with the reduction of powerful policy tailwinds.”