© By Jamie McGeever ORLANDO, Florida () – A flattening yield curve and declining consumer confidence have been warning for months that US recession risks are mounting, but alarm bells are suddenly heightened by a rare quirk in the interest rate futures market. Technically, the euro-dollar curve has inverted from June 2023 to December 2023. In plain English, traders will start pricing in the Federal Reserve’s rate cuts in the second half of next year, before the tightening cycle has even started. This inversion had previously been seen further off the curve, into 2024. But that was before the war in Europe, dazzling increases in oil, gas and commodity prices, and the craters of world markets radically changed the dial. Certainly, the Eurodollar curve is not a pure snapshot of the Fed’s expected policy trajectory. It may be skewed by perceived credit risk and strong demand for hedging from a wide range of players, including foreign governments. But as Joseph Wang, a former trader on the Fed’s trading desk, points out, it’s unusual and deserves attention. “This is rare, but we have rare events. There is an enormous amount of uncertainty,” Wang said. “The core of the financial system, the banks, will be fine. But there is definitely concern about contagion and there may be reverberations that people are not aware of.” FCI, 6 YEAR HIGH Could the US economy slip into recession next year or even this year? Economists are lowering their 2022 growth forecasts to 3%, from 4% at the start of the year, with risks still largely on the downside due to oil. Average gas prices at US pumps are now the highest ever. An annual growth of 3% would not come close to a contraction. But global geopolitical and financial developments are moving so fast that there is little visibility for the coming weeks, let alone for the rest of the year and beyond. According to the Goldman Sachs (NYSE:) Global Financial Conditions Index, global financial conditions are now the tightest in six years. Higher yields, wider credit spreads and lower equities have all contributed to the rapid tightening this year. The direct exposure of the US economy to Russia, Ukraine and Eastern Europe is small. The eurozone, for example, will be hit much harder by the raging conflict and energy prices. But US consumer confidence has fallen to a 10-year low, and it’s just 20 basis points from a decline below two-year yields. Every recession in the US in the past 40 years has been preceded by a sharp decline in consumer confidence and a yield curve inversion. BEAR MARKET While high and rising inflation was on everyone’s radar at the start of the year, no one had a recession in their 2022 playbook. “Markets should focus on the growth outlook and the pace of its slowdown rather than inflation risk, which is already priced into bond and commodity markets,” Unigestion’s Guilhem Savry wrote on Tuesday. The rosy growth outlook around the turn of the year was one of the pillars on which the stock market consensus that was as optimistic as it was broad for 2022 was built. A cursory look back through Wall Street’s 2022 banking outlook shows that the “R” word was barely mentioned. Yes, earnings growth could slow and valuations looked a little rich, but as long as the economy avoided a recession, Wall Street would rise another 10%. Bank of America (NYSE:) research highlights the magnitude of investors’ economic optimism and bullish market in January: The gap between bullish stocks and bearish bonds was historically wide, only 7% of investors expected a recession this year, and less than a third expected a bear market this year. Even more astonishingly, BofA found that a record $949 billion flowed into global equity funds last year, more than in the past 20 years combined. Even assuming some of that flow naturally evaporates as Wall Street goes down — the Nasdaq turned into a bear market this week — and most of it remains invested, there’s still potential for massive relative value shifts or reallocation to safer assets. . “We are firmly in the grip of a bear market that is incomplete in both time and price,” Morgan Stanley (NYSE:) stock strategists wrote Monday, adding: “As such, we recommend staying defensively oriented by taking less risk than normal.” (The views expressed here are those of the author, a columnist for .) (By Jamie McGeever, with additional contribution by Mike Dolan; edited by Andrea Ricci)
