(Bloomberg) — As the prospect of a recession on Wall Street fades, markets are back to being vulnerable to any signs that the U.S. economy is overheating.
Most read from Bloomberg
From high-yield credit to equities, the economy’s ability to convert into financial assets fell to its lowest since April 2022, according to JPMorgan Chase & Co. It’s a major reversal from the doom and gloom of the previous year, when the recession was effectively seen as a done deal.
That means the markets are increasingly reacting to economic news that could signal another wave of inflation, which could pose a problem for interest rate strategies. For many investors, positive economic data — and its potential to trigger further policy tightening — is a headwind they’re battling.
“I worry that the current good economic data will allow inflationary pressures to fly through the cracks,” said Marija Weitman, senior multi-asset strategist at State Street Global Markets. “This will prevent the Fed and other central banks from cutting rates, which will ultimately destroy the economy.”
Thursday’s strong jobless claims figure and Wednesday’s better-than-expected service sector activity, for example, bolstered the case for the Federal Reserve to raise rates, exacerbating the decline in equities.
Even investors in government bonds — one of the few markets where bearish bets have gone wild — aren’t fainting these days on stronger-than-expected data.
The dreaded inversion of the Treasury yield curve, a traditional economic warning sign, is finally easing. And traders have been preparing bets on how much the Fed will be forced to cut interest rates next year to fight the recession in the past two months.
One way to think about how sensitive the market is to new economic data is to look at the S&P 500 and Citigroup Inc. The correlation between a widely followed surprise index for the US economy.
That 40-day correlation fell to the most negative on record, meaning stocks fell as big-picture data from employment to manufacturing ran hotter than economists expected. On the other hand, it is a surprise rally.
The correlation between Treasuries and data has also turned negative, with economic strength reflecting weaker bond prices.
“We are in the ‘bad news is good news’ part of the cycle,” said Yung-Yuma, chief investment strategist at BMO Wealth. “The reason is that the market is concerned about the Fed raising interest rates again,” they wrote. Note.
A sudden burst of bad economic news clearly has the potential to trigger global volatility. But now the good news may be the biggest risk, bringing inflation and higher policy rates that hurt corporate earnings, dampen business investment and threaten consumers with higher debt burdens.
Bloomberg strategists say…
“And so we’re left in a sort of economic and market vacuum, where the curve is saying everything is going to hell, but risky assets are waiting for the prospect of a nirvana-like soft-landing.”
– Cameron Crisis, macro strategist
Click here for the full report
For their part, Fed policymakers are doing their best to reverse bets on easy policy — and to keep markets on course for more growth.
Traders compared the Fed’s rate hike to around 100 basis points next year, down from 150 basis points in early 2023. Meeting on September 20.
With the U.S. economy shrinking at a 2% clip, even the Fed staff wrote off their forecast for a recession this year. One widely followed, unofficial tracker from the Atlanta Fed shows the U.S. economy expanded at an annualized 5.6% in the third quarter.
“I think markets are skeptical of a recession until they see the whites of the eye,” said James Rossiter, head of global macro strategy at TD Securities. Now, after this year’s arrest, he expects a recession in the US at the beginning of next year. “For the past year or so, people like me have cried wolf over recessionary forecasts, only to see the world turn out better than feared.
Like him, investors in property are rethinking the recession. Equity, credit and stock markets together are predicting a 16 percent chance of a U.S. recession over the next six to 12 months, down from more than 50 percent in October, JPMorgan’s trading model shows.
The S&P 500 is assigning just a 22% chance of a fall, down from 98% in October, while the junk bond market sees a 9% chance. The bank calculates metrics by comparing various segments and their pools during recessions to pre-recession heights.
Some worry that the reversal has gone too far, with a hot economy pushing consumer price pressures too high for the Fed’s comfort. Soft landings, where inflation and the economy can accelerate unhindered, have eluded most policymakers for the past half century.
“Goldlocks can be a way station to a better or worse growth backdrop,” said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors. “In a strong growth environment, higher inflation should be given, and the market should struggle with further price increases.”
Most read from Bloomberg Business Week
©2023 Bloomberg LP
