Kolanovic: Recession ‘Difficult To Avoid’

A recession may be “difficult to avoid.”

That’s according to JPMorgan strategists led by Marko Kolanovic, who worry that absent a “meaningful” Fed pivot, the US economy could be headed for a downturn.

Although October’s below-consensus CPI print (and, on Tuesday morning, a similarly soft read on factory-gate prices), was good news and might’ve “rais[ed] the likelihood of a soft landing,” Kolanovic and company nevertheless fret that if Fed funds reaches 5%, a recession may be the base case.

On Tuesday, following the PPI numbers, market pricing for the terminal rate sat at around 4.88%, near the post-CPI lows (figure below).

Fed speakers continued to parrot some version of the same general narrative this week. I’m not sure how much utility there is in obsessing over every turn of phrase. It’s obvious the Committee is inclined to reduce the pace of hikes if the data cooperates and market pricing remains consistent with 50bps for December (if pricing drifts back towards 75bps for next month’s meeting, officials would need to be cautious about delivering a relative dovish surprise).

At the same time, nobody at the Fed wants to relent on the “higher for longer” narrative, which means that regardless of what the actual terminal rate ends up being, the plan is to get somewhere in the area of 5% and stay there for at least a few months. If “a few months” ends up being — I don’t know — a few more months than the market is priced for, it could be too much for the economy (assuming, of course, that STIR traders possess some special knowledge about economic tipping points). That’d be particularly true if the already deep housing correction morphs into a proper bust, for example.

The table (above) shows JPMorgan’s house calls for policy rates versus market pricing.

Despite retaining an Overweight in equities, JPMorgan’s strategists said their “optimism is tempered by the still elevated recession risks, and risk that the October CPI data proves anomalous and/or fails to reduce central bankers’ eagerness to push policy into more restrictive territory.”

Certainly, the word “restrictive” is en vogue at the Fed. It made its way into the policy statement this month, and officials, including Powell, use it regularly to emphasize that despite 375bps of tightening already delivered, policy still has “a ways to go” before it’s “sufficiently restrictive” to put continued downward pressure on inflation.

The “inflation slide” is likely “to slow central bank tightening and boost consumer spending but [policymakers] are still on the move and threaten an early end to the expansion,” Kolanovic and company wrote, on the way to making “several adjustments” to their model portfolio, including a cut to the equity Overweight.

In addition to still high recession risks, JPMorgan cited “the strong market rally last week,” the scope of which might “suggest much of the increased soft landing probability is priced in.”