Is Recession Coming?

In mid-November of 2022 the market is still very much focused on inflation, interest rates, and the future plans of the Federal Reserve. However, a new issue is starting to work its way into the minds of investors and analysts.

Market Issue Focus

The market has a habit of being hyper focused on a singular issue for a period before completely disregarding it and moving on to a new issue to hyper focus on. For example, the market used to swing wildly when Covid infection numbers were released. Then inflation became the star of the show and Covid case numbers were a thing of the past. Before Covid it was the trade deal with China, and on and on. The good news is that inflation is likely starting to come down. The last CPI report was better than expected. There are a lot of indicators out there that tell us inflation is at least heading in the right direction. The Federal Reserve will likely hike rates a few more times and then be done. Once the rate hike cycle is over, we think the main market driver will be recession, and specifically, if we are going to have one. And if we do, how bad will it be?

It’s important to know when the market shifts focus to a new issue. The market will react to news differently depending on what the main problem is at any given time. For example, during Covid, bad economic data was actually good for the market because it meant the Fed would likely not raise interest rates. Bad news was good news. This is still the case. The market wants the Fed to stop raising rates as soon as possible, and one of the reasons they will do so is if the economy begins to suffer. Therefore, good economic news is still bad news for the market. However, this notion is about to change.

Yield Curve Indication

When the market is concerned with a recession, good news will be good news again and bad news will be bad news. The economic data that is released regularly will start to move the market more dramatically as we try to predict if we are in a recession, and just how deep that recession may go. The likelihood of a recession, at this point, is pretty high. Let’s consider the yield curve. An inverted yield curve is when the 2-year Treasury pays a higher interest rate than the 10-year Treasury. If the market players are worried about potential economic growth, short-term yields will rise as investors look to invest in longer-term bonds. It should be noted that an inverted yield curve has predicted the most recent 10 recessions. So, the fact that the yield curve is at one of the most extremely inverted positions in history is not all that comforting.

The yield curve is an indicator, though, not a forecast. Using the yield curve as the only point of data will not paint a complete picture. You need to look at the economy as a whole, along with the trend of inflation, the creation of new jobs, wage growth and what the Federal Reserve says. Only then can you make educated guesses about the economy's future direction.

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