Recession Panic Crescendoes With Trio Of 2023 Fed Cuts Seen

The US is “perilously close to a recession,” JPMorgan’s Michael Feroli said Friday.

The bank slashed its outlook for the world’s largest economy citing this week’s poor data, which drove a widely-followed real-time estimate of quarterly GDP into contraction territory. The bank still sees an expansion, though, in part because employers are likely to retain workers after struggling with an acute dearth of labor for the better part of two years.

Meanwhile, Larry Summers told Bloomberg’s David Westin that “the risks of a 2022 recession are significantly higher than I would have judged six or nine weeks ago.” On the bright side, a downturn would “probably” reduce inflation, Summers mused.

Following Friday’s data, which included a lackluster ISM manufacturing report, the Atlanta Fed’s GDPNow tracker fell even further into negative territory. At -2.1%, it’s dropped precipitously over the past several updates (figure below).

According to the nowcast, real personal consumption growth is currently running at just a 0.8% clip.

The ongoing descent into a summer recession has bonds in rally mode. 10-year yields were as low as 2.787%, while two-year yields are now ~60bps off 2022’s highs reached prior to the June FOMC meeting.

As BMO’s Ian Lyngen and Ben Jeffery put it Friday afternoon, “There is an embedded unknown in the price action in US rates — how much of the bid for front-end Treasurys is based on the assumption that the Fed won’t have the conviction to push either so quickly or dramatically higher in policy rates in the face of even a mild recession or alternatively, will a recession do the bulk of the heavy lifting for policymakers by crushing demand earlier in the hiking cycle, thereby curtailing the need for the Fed to get the target range close to 4%?”

Whatever the answer, recession concerns are bleeding into front-end pricing. Nomura’s Charlie McElligott cited “obvious stop-out pain” in STIRs and bonds tied to hard landing worries. It’s all “spiraling into a purge of legacy commodities longs,” he said.

The figure on the left (below) shows that on Nomura’s model, CTA trend’s net long exposure to commodities has plunged from 99%ile earlier this year to just the 35%ile, with exposure to agriculture and industrial metals trimmed against a sticky max long in energy.

The market is now pricing a trio of Fed cuts (plus a little) for next year (figure on the right, above). That’s a function of capitulation at the front-end, but from a macro perspective, it’s indicative of recession becoming everyone’s base case.

“It’s not just a positioning cleanse,” McElligott added, citing “clear macro catalysts” for growing confidence in duration longs which, just a couple of months ago, were tantamount to putting bleach in your gimlet. Or in your veins.

Meanwhile, TD’s Priya Misra thinks the rally at the front-end may have gone too far. She doubled down on a two-year short Friday after ISM prompted yields to plunge into what she aptly described as “an illiquid, holiday shortened session.”

“The pricing of the terminal rate has fallen to 3.25%,” Misra wrote, before explaining why being tactically short 2s may make sense. “We expect an above consensus payroll report and even though we forecast services ISM to decline, we expect it be a solid 54 [which] should ease some recession fears,” she said, on the way to suggesting the June FOMC minutes, due next week, “will reinforce the Fed’s ‘unconditional’ focus on inflation.”