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Markets appear extremely concerned about the possibility of a U.S. recession. In the fixed- income markets, an inverted yield curve, with short-term rates exceeding long-term yields, has been a reliable indicator of the potential for future economic challenges. And, it has not been this inverted in four decades (Figure 1).
Figure 1: Inverted Yield Curve
Indeed, there is plenty of evidence to support the possibility of a U.S. recession in 2023. The Federal Reserve (Fed) is aggressively raising short-term interest rates. Mortgage rates have surged, while house prices are weakening (Figure 2). Announcements of layoffs in the financial and social media sectors are piling up. Measures of consumer sentiment are seriously depressed. Globally, China is struggling to regain economic traction after a tough year, the Russia-Ukraine War is grinding on, and Europe faces its own possibility of recession.
Figure 2: House prices are weakening as mortgage rates surge
It is an open question as to whether equity markets agree with the fixed-income market’s view that a recession might be on the way. In 2022, when U.S. Treasury 10-year Note yields rose sharply (that is, prices declined), one could argue that much of the bear market in equities was reflecting an adjustment to the new competition from bonds, and not really a forecast of a future recession (Figure 3). Still, most analysts would suggest that at the least, equities are discounting the probability of a slowdown in the U.S. economy that might tilt into a shallow recession.
Figure 3: U.S. 10-Year Treasury note yields rose in 2022
Yet, it is not all gloom and doom. While some sectors are losing jobs, others are hiring workers, and the unemployment rate remains below 4%. Various inflation indicators, such as prices for a range of commodities and gasoline, are much lower (Figure 4). Durable-goods inflation is receding rapidly. Even rents appear to have peaked. And, the latest consumer price data showed a further reduction in headline inflation. The Fed and market participants will probably view the latest data on inflation as a positive sign, yet core inflation is sticky but even if improving, may remain well above the Fed’s 2% target in the coming year.
Figure 4: Gasoline prices have retreated from their June peak
Bottom Line
For sailors, navigating in the middle of the night when one cannot see what is ahead is always a challenge. But daylight always follows the night. Is the sun about to rise on consumer sentiment? Are some of today’s uncertainties about to become less murky? Time will tell, and we do not know the answer. Perhaps for markets and risk managers, the most important change in sentiment is not when it shifts from negative to positive, but when sentiment shifts from negative to less negative.
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Image and article originally from www.benzinga.com. Read the original article here.