Who wants a recession?

Stocks rallied for a mixed close last Friday as investors picked up the pieces from Thursday’s post-Fed selloff. Investors rejoiced in a relatively stable bond market after a wild week of yield swings.

Long days. Summer officially started as I was doing research for this morning’s market note. Today marks the first official day of summer – the summer solstice. It is, by definition, the longest day of the year. I spent a bit of time reflecting on last week’s markets over the extended weekend and came to the conclusion that last week was probably the longest week of the year from a market perspective. Let’s start with the Fed, which raised its key lending rate by +75 basis points for the first time since the 1990s. It was in 1994, to be more precise, when the Fed hiked interest rates by +25, +25, +25, +50, and +75 basis points in succession. Another +50 basis point hike would come in February of 1995 before the Fed would shift into cutting. Ok, so here is the news that you really want to hear: there was no recession as a result of the hikes. Here is the bad news you don’t want to hear: inflation was nowhere near where it is today.

This is where the challenge begins. Fed rate hikes are designed to be a burden on consumers; they are supposed to incentivize us to slow down on the buying sprees which are a key driver of inflation. The problem is that inflation itself is ALSO a burden on consumers. In other words, its double the pain for your money, and that pain is more acute today with inflation at +8.6% compared to the 2% to 3% of the late 1990s. There was some more aggressive hiking, albeit in smaller increments in the late 1990s until the US did actually fall into a recession by 2001, though it had more to do with the bursting of the dot-com bubble than with inflation. In the wake of that recession, larger-sized rate cuts became the norm as did the expectations for the +25 basis point hike norm.

So, all of that changed last week when the Fed, under intense pressure, raised interest rates for the first time since 1994 (now you know the history). You may think that the unprecedented move was the cause of last week’s market turmoil, but the reality is that the market had fully factored in the +75 basis point bump as well as the more aggressive path forecast by the Fed for the balance of the year. The market’s initial response, on the day of the announcement, was a sigh of relief rally. The sigh of relief was in response to the Fed’s doing as the market predicted and not something more radical, like a +100 basis point raise. Thursday’s selling came as investors began to contemplate the possibility of recession compounded by the fear that the Fed, despite its best efforts, would be unable to tame inflation.

It is important to remember that the Fed, even though it is credited with causing recessions, does not actually cause the recessions. Further, it is not the Fed Funds rate, by itself, that causes consumers to stop spending money, leading to a recession. A big part of consumer behavior is sentiment. If consumers start to believe that a recession is on the horizon, they will begin to tighten their purse strings. Sure, lower demand will cause inflation to slow, but it can also push the economy into contraction, which is a fancy word for recession. So, once consumers begin to expect, they also start to accept that a recession will occur, and this plays a big role in causing the technical recession.

If we just go by the numbers, the economy is somewhat healthy, driven by still-strong consumer demand and low unemployment. The Fed, based on its last week’s release, is not predicting a recession in the next 3 years. Indeed, a survey of economists predicts, on median, that the probability of a recession in the next year is just 31.5% skewed to the left. That means that the bulk of economists are on the lower side. The problem with those numbers and surveys is that they represent a snapshot. It is more instructive to observe the change in predictions over time, and that shows us a trend of increasing probability. Now let’s take a step back and look away from the numbers. More and more CEOs are mentioning the word “recession” in their guidance, which means that they will be pulling back on corporate spending in the weeks and months ahead. We have already heard in the news of hiring freezes and force reductions, though it is not universal. Even though a CEO does not mention recession, you better believe that he or she is paying attention to what others are saying. I know that I have mentioned it more than once, but Target’s and Walmart’s admissions of inventory buildups and reduced demand are clear indicators that consumers may be starting to get the message loud and clear. That message is that the possibility of a recession is growing, you just have to listen to what your friends, family, and the Fed is saying. To be clear, that doesn’t mean that those fears will manifest in a recession for certain. A good way to look at that is that there is a 68.5% chance that we won’t enter a recession in the next year, according to an economist survey. That feels much better, doesn’t it? Happy summer.

LAST FRIDAY’S MARKETS

Stocks rallied on Friday with indexes closing mixed as investors sentiment improved slightly. The S&P500 rose by +0.22%, the Dow Jones Industrial Average lost -0.13%, the Nasdaq Composite Index jumped by +1.43%, and the Russell 2000 Index traded higher by +0.96%. Bonds gained and 10-year Treasury Note yields gained +3 basis points to 3.22%. Cryptos fell by -0.76% and Bitcoin lost -0.23%.

NXT UP

  • Chicago Fed National Activity Index (May) is expected to come in at -0.47, same as April.
  • Existing Home Sales (May) may have fallen by -3.7% after falling by -2.4% in the prior period.
  • Today’s Fed speakers include: Barkin and Mester. Pay attention to these…everyone wants to know what the Fed thinks these days, so the market is likely to react.
  • Later in the week we will have more Fed-speak (including the Chairman), more housing numbers, PMIs, and the University of Michigan Sentiment. Please refer to the attached calendar for times and details.

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