“Recession shock” vs. “gentle landing”
“The ‘inflation shock’ is getting worse, the ‘interest rate shock’ is just beginning, the ‘recession shock’ is approaching,” Michael Hartnett, BofA’s chief investment strategist, told Reuters on Friday. In a note to customers, he noted that in this context, cash, commodities and cryptocurrencies could outperform bonds and stocks.
Following the aggressive speeches of Fed officials and the publication of the minutes of its last meeting, the forecasts for the recession are rapidly changing from rather marginal to mainstream. And Deutsche Bank was certainly right about that, the first of the big banks to certainly predict a recession on Tuesday. “Our signal for US recession next year is now beyond consensus,” wrote economists David Folkerts-Landau and Peter Hooper. “We expect this to be short-lived.”
So far, those who claim to believe in the possibility of a “soft landing” (to beat inflation without the economy falling) by the Fed are in the majority. It is true that many are already insured. For example, earlier this week, Goldman Sachs spoke on the one hand about the growing risk of recession and on the other hand claimed that its probability within 24 months is 38%. The chances of success for the Fed turned out to be clearly higher than for failure, but another scenario is also clearly indicated.
In any case, as of Tuesday – after the first words of the member of the Fed board, Lael Brainard, for the reduction of the Fed balance sheet since May – the alternation of the sectors in the portfolios intensified. . Investors mainly sold shares that traditionally suffer from rising interest rates, but at the same time got rid of some others, shifting to defense securities. Government bond yields began to rebalance for three years and the dollar on the world market rose.
Other Fed statements and minutes in the following days only supported this process. The market believed that in May it will not increase only by 50 bp. interest rate, but also the Fed balance sheet will begin to shrink. The limit will be $ 95 billion a month and things will go much faster than in 2017-2019. At the time, the limit was $ 50 billion, but that is not the point. It took a year to reach that time, and the decline began a few years after the first rate hike. And yet, at the end of 2018, a downward market for equities began, so the Fed had to slow down.
Now we are talking about a matter of months – according to the protocols, the limit of 95 billion dollars will be reached within 3 months or a little later, “if market conditions require it”. But what can you do – the Fed is preparing for a tough battle against inflation, which is already rewriting the records of the early 1980s.
Waiting for the storm
By Friday, the yield on the US 10-year bond reached 2.73%, the highest level since March 2019. The US dollar index (against a basket of six top currencies) rose above 100 for the first time since May 2020. Shares fell: Dow Jones Industrial Average lost 0.28%, S&P 500 lost 1.27% and Nasdaq Composite lost 3.86%.
The difference in the scale of the fall of the indices is explained by the different share of technological and other sold shares, as well as by the weight of the securities classified as hedging. First of all, investors got rid of growth stocks, which are particularly sensitive to high rates. We were looking for companies with fixed profits and dividends. We bought securities from sectors such as consumer goods and healthcare, for example. Traditionally, they are considered suitable in case of recession.
As a result, stocks such as Pfizer, UnitedHealth Group and Merck closed the week up 7%, 6.5% and 5% respectively. Walmart added 3.7% and Procter & Gamble 3.2%.
Due to the change in the attitude of investors in various market segments on Friday, the indices even closed in different directions: the Dow rose 0.4%, the S&P 500 lost 0.27% and the Nasdaq collapsed 1.34%. The former was further aided by the growth of interest-sensitive banking stocks.
During the day, shares of Goldman Sachs Group rose 2.3%, JPMorgan Chase & Co – 1.8%, Citigroup – 1.7%, Bank of America Corp – 0.7%. This may indicate that their customers still believe in a smooth landing. In case of slow, but still GDP growth, such shares are an option. But during a recession, especially if it turns deep, this is far from the best choice.
Some analysts, in fact, are now convincing consumers that the Fed will seek to curb inflation without causing a recession. Inflation will fall before the end of the year, they say, and pigeons will come to the forefront of the Fed before the recession begins. Current US financial statistics look good so far, so there is definitely a temptation to believe them. But market skepticism is growing.
“The outlook is becoming increasingly bleak as investors and economists continue to lower their growth expectations,” Bryce Doty, senior portfolio manager at Sit Investment Associates, told Bloomberg on Friday. “The opposite wind continues to intensify. So stress accumulates. “It’s like reading the weather forecast – reading that a storm is coming, even though it’s a clear, sunny day.”