With inflation soaring, bond yields climbing and the Federal Reserve poised to impose big interest-rate hikes, many economists and investors are worried about the prospect of recession.
Goldman Sachs strategists say the risks are growing, but it’s “too early for recession obsession,” they wrote in a commentary.
“With elevated inflation, slowing growth from the covid rebound and a historically tight labor market, stagflation concerns remain high among investors,” the strategists said.
“And with the Fed embarking on one of the steepest hiking cycles since the 1990s, there are also growing concerns over recession risk.”
Consumer prices jumped 8.5% in the 12 months through March, and interest-rate futures traders see a 71% probability that the Fed will raise rates by at least 2.25 percentage points for the rest of the year.
Indicators 'Send Mixed Message'
“To gauge the market-implied probability of a recession, we look at a broad range of leading and coincident market indicators,” the Goldman strategists said.
“Currently they send a mixed message, with cyclicals versus defensive [stock] valuations and the two-year/10-year yield curve more bearish, and other indicators less so.”
The two-year Treasury yield exceeded that of the 10-year for several days starting at the end of March, meaning the yield curve was inverted.
“This is usually an early recession warning: … since the late 1980s the time lag between U.S. yield-curve inversion and U.S. recessions has been on average 20 months,” they wrote.
“That said, there are often wrong signals. In periods of high inflation the yield curve has inverted deeper before a recession, and combining different segments of the yield curve points to a low probability of recession in the next 12 months."
The market-implied probability of recession currently stands at 20% to 30%, the strategists said. Probabilities at that level have historically been followed by a recession within 12 months, 28% of the time.
As for how to play stocks during this period: “Market timing around recessions is notably difficult,” they said.
“Market-implied recession probabilities can help. But investors need to balance the ‘time in the market’ with ‘timing the market,’ as divesting too early can mean giving up positive equity returns.” The strategists remain overweight stocks.
Morgan Stanley and Larry Summers
Morgan Stanley strategists also are concerned about recession. “Growth is slowing and likely more than most forecasts incorporate, especially for 2023 when the risk of recession has increased the most,” they wrote in a commentary cited by Bloomberg.
The Harvard economist Larry Summers has been warning about the increasing risk of recession for some time.
“If you look at history, there has never been a moment when inflation was above 4% and unemployment was below 5% when we did not have a recession within the next two years,” he told Bloomberg. The unemployment rate totaled 3.6% in March.
“So I think the odds on a hard landing within the next two years are certainly better than half, and quite possibly two-thirds or more,” Summers said.
Summers earlier served as U.S. treasury secretary and director of the National Economic Council.
