Recession or no recession?
Talk of a recession in the US is again in the air. Last autumn, when the Federal Reserve was on its path of ‘normalisation’ by increasing interest rates, we thought a recession close to inevitable. The authorities have changed tack abruptly, and we commented in January that it might or might not be too late to prevent a US downturn.
More recently we have had that classic sign of recession, an inverted yield curve, as US longer bond yields have fallen beneath short rates. As a result, recession talk has risen.
We have two reasons for believing that, while it is certainly a possible outcome, it is not yet baked in. We have written before why there are technical reasons for the sharp fall in longer term US bond yields, which are more to do with the financial system’s demand for ‘safe assets’ and less to do with risk appetite. We also note that our friends at CrossBorder’s major liquidity index at the end of May was still just above recession level, and policy stance at both the Fed and PBoC in particular are close to neutral.
That said, what we have noticed is a sharp fall in investors’ risk appetite as measured by cross-border flows and investor sentiment. It looks as if more investors have already positioned themselves for an economic downturn, which suggests the market impact of one may be less dramatic than expected. We also believe, as we have commented before, that the Fed would react with a new QE programme. This would aim to limit the extent and impact, much as in 2008/9.
So, recession or no recession? We don’t know the answer and we don’t wish to sound overly complacent. However, we are not yet convinced that a recession in the US is certain and we do believe that, if there is one, the impact on markets will be short-term rather than extended.