Charts of the Week: The Fed’s Woes

Summary

• The Fed is struggling to cool the economy.
• Markets are pricing out Fed hawkishness.
• Recession probabilities are at a 20-year high.
• And US stocks just bounced, again…

The Fed Is Struggling

The Fed has been hiking aggressively, but the impact of tighter financial conditions on the economy has been hard to see (Chart 1). Employment growth, a good indicator of economic activity, has barely slowed. We think this could be because financial conditions impact the real economy less than consensus assumes. And that is a problem for the Fed…

US 10y Yields Fall

US 10y yields have fallen from almost 4% to almost below 3.6% over the past week (Chart 2). Decomposing the move, the bulk of the decline has come by a drop in 2y real yields. This suggests that markets are pricing out Fed hawkishness with a belief that the Fed is more concerned about financial stability and recent weak data (ISM). Find out how we are thinking of trading this after US payrolls.

Models Imply US Recession Nearly Certain

Our recession model, which uses the 2Y10Y part of the yield curve, now assigns a 77% chance of a recession within the next 12 months (Chart 3). It has been signalling at least a 70% chance of recession consistently since 13 September. Meanwhile, the Fed’s recession model, which uses the 3M10Y part of the yield curve, produces just a 15% chance of recession. The probability of recession increases with yield curve inversion.

US Equities Are Bouncing Again

We have seen a sharp bounce in stocks since the start of the month. US stocks are up almost 6%. We are cautious in extrapolating this strength as markets are likely affected by large month- and quarter-end flows. Indeed, our analysis finds that over the past year, on around 70% of occasions, the first week of the new month sees stocks move in the opposite direction to the last week of the month (Chart 4).  

Matthew Tibble is Commissioning Editor at Macro Hive. He has worked as an editorial consultant and freelance editor for companies such as RiskThinking.AI, JDI Research, and FutureScape248.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)