Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Over the last few months, markets have moved away from worrying about inflation, to worrying about recession, and then to not worrying about too much at all, certainly, in terms of economic risk. This is fairly standard. The psychology that drives markets means that excessive risk aversion or excessive risk appetite often dominate for extended periods.
Or are markets right to stop worrying about a hard or soft landing or indeed to believe in a ‘no landing’ for the US? We certainly have had some very strong US economic data of late, particularly US jobs data and US ISM (Institute for Supply Management) Services data.
That said, ISM Manufacturing data was weak, while the jobs market is notoriously poor at providing advance signals of recession. In contrast, one of the most reliable indicators of recession has been the inversion of the yield curve. A standard measure is the 2s10s, this is the difference between the 10-year US Treasury yield and the 2-year US Treasury yield illustrated below, which is giving a very clear signal of recession. It has inverted prior to all the last ten US recessions and is now more inverted than at any time since the 1980s.
US 2s10s yield curve: materially inverted, for an extended period
Source: Bloomberg data from 07.02.2018 to 08.02.2023. Past performance is not a reliable indicator of future returns.
A distorted signal?
We often get asked if the signal is distorted this time due to significant Fed intervention in the bond market. There is likely some truth in this, but we think that it’s not so much why this measure inverts, but what it does to behaviour. For example, a steep curve encourages entrepreneurial behaviour, as borrowing costs at the short end of the curve are lower than potential returns at the long end of the curve.
In contrast, when the curve is inverted, behaviour is encouraged to be less entrepreneurial, with more assets deposited in safe assets at the shorter end, rather than investments in the long end.
Looking beyond developed government bonds, it is clear that risk assets, for example equities and high yield corporate bonds, are not behaving in a way that is consistent with recession, although their record is less credible. Looking at company level signals, Quarter Four 2022 corporate profit results are mixed so far.
A mixed bag to work with
Macro-economic measures have a bit of everything for hard, soft and no landing protagonists. Markets are signally no landing, for example equities and corporate bonds, though the more reliable ‘inversionistas’ are shouting recession, while the corporate earnings season is not providing much clarity either way.
What about monetary policy? If we assume a no landing, as many would have us believe, surely that argues against a Fed pivot (to cutting rates) and instead a Fed pause. However, whilst markets are pricing in a higher terminal official rate (peak rate) of late, they still have falling rates pencilled in for this year.
Bringing all this together, it seems clear that, whilst the short-term disinflationary environment for consumer price inflation is clear, the outlook for core services inflation (a key focus for the Fed) and US economic growth, and therefore US official rates, remains unclear. However, the market may want it all: a no landing and a pivot. This seems unlikely to us
In part this is reflected in the apparent contradictions between the positive signals from risk assets, vs the negative signals from the yield curve. We expect pockets of turbulence as the data becomes clearer and sections of the market adjust their differing base cases. This will not just be important at the aggregate indices level, but at an equity sector level too.
