A Different Worry
Is recession a problem?
I’ve spent a lot of time talking about how markets have become very worried about stagflation. Partly due to some comments from big banks over the weekend, I want to talk about another worry that seems to be gaining early momentum, the fear of recession.
The reasoning behind a recession call should be fairly obvious. An energy shock will go through the economy, raising prices and slowing the economy. I’m sympathetic to the idea, but I think it’s too early to make that claim with confidence. There’s a difference between sustained $150 oil and a few weeks of $100 oil.
No doubt, this is an uncomfortable situation, as there’s not a whole lot the Fed can do about a sudden rise in oil. Potentially rising inflation while threatening the jobs market is just the sort of thing the Fed can’t do much about. It also doesn’t help that the economy was already starting to get recession questions.
Even outside of oil, the market was already worried about a flattening pace of job creation. To some extent, that can be excused as illegal aliens leaving the workforce, but if still seems like a problem. Additionally, the consumer has started to look worse, with a weakening trend in retail sales metrics. Wrapping it all up, the Atlanta Fed’s GDPNow estimate has dipped to 2%, over a percent lower than it had been early in the month.
So, should we prepare our recession trades? I think that’s a bit hasty. A lot of this stress can get alleviated quickly, broadly through an Iran deal. In the meantime, earnings estimates have held up very well. If we can get liquidity to return to the market, we can have a powerful rally.
It’s possible we get a recession but trying to call it now is a pretty risky proposition, in my book. Powell’s dovish speech today helps show that nobody wants a recession, here. We have a broadly supportive environment that’s arguably just waiting for the all-clear on stagflation concerns. A recession trade would be 180-degrees away from that while future direction is still pretty uncertain.
On the flip side, one bonus of the US being so slow to cut rates versus the world is that the US is still reasonably restrictive. There’s plenty of room to cut rates and engage in deregulation to support any weakening in the economy. No official, including Powell, seem to view inflation as a primary focus. Inflation breakevens have actually been moving down, lately.
This definitely hasn’t been an easy market, with plenty of noise. I don’t think you can confidently predict the future, here. What I would say is that stagflationary pricing looks like it may have peaked, last week. Is it appropriate to price in a recession? I can understand the desire, and it may even be right, if oil can continue to go up. Given the data we have today, I think calling for a recession is very aggressive. We don’t yet have that data and there’s a lot of firepower for the government to fight a recession, right now.