To borrow from Dickens, “It was the best of times, it was the worst of times.” It just depends on whether you are listening to the stock or bond market. While stocks are still a long way from the January 2022 highs, markets have rebounded sharply. The S&P 500 Index has climbed over 15% from the October lows. This suggests that corporate earnings, and the economy at large, are in pretty good shape. Meanwhile, the bond market is deeply inverted and Fed Fund Futures are pricing in 2 rate cuts later this year. It seems the bond market is convinced that a recession is coming soon.
To be fair, there have been conflicting economic signals for some time now.
Best of Times
To be fair, there have been conflicting economic signals for some time now.
Best of Times
• Stocks, especially large cap growth stocks, are enjoying a strong 6 month run.
• The labor market has showed some signs of weakening, but remains very tight. Unemployment is just 3.5% and there are still almost 2 open jobs for every unemployed person.
• First quarter Gross Domestic Product (GDP) is expected to have grown at a 2.5% annual pace according to the Atlanta Fed’s GDPNow forecast. If there is going to be a recession, it did not start in the first quarter.
• The labor market has showed some signs of weakening, but remains very tight. Unemployment is just 3.5% and there are still almost 2 open jobs for every unemployed person.
• First quarter Gross Domestic Product (GDP) is expected to have grown at a 2.5% annual pace according to the Atlanta Fed’s GDPNow forecast. If there is going to be a recession, it did not start in the first quarter.
Worst of Times
• The bond market is deeply inverted and Fed Futures are pricing in rate cuts later this year.
• Silicon Valley Bank and Signature Bank collapsed in the first quarter. While a wide spread banking crisis now seems unlikely, this is a sure sign that the aggressive Fed action is having an impact and liquidity is drying up.
• Housing starts are 21% below the level from a year ago while mortgage applications are off by 36% as a result of higher interest rates.
• Inflation has cooled, but remains well above the Fed’s 2% target. This means the Fed will probably hike at least one more time in May before pausing.
• Silicon Valley Bank and Signature Bank collapsed in the first quarter. While a wide spread banking crisis now seems unlikely, this is a sure sign that the aggressive Fed action is having an impact and liquidity is drying up.
• Housing starts are 21% below the level from a year ago while mortgage applications are off by 36% as a result of higher interest rates.
• Inflation has cooled, but remains well above the Fed’s 2% target. This means the Fed will probably hike at least one more time in May before pausing.
Ultimately, we believe the Fed will succeed in bringing inflation down. Maybe not all the way to the 2% target, but the Fed and Chair Powell’s credibility are dependent upon their success in stabilizing inflation. The question is whether they can land the economy softly, as stock prices suggest, or will it be a thud as bonds seem to foretell.
Market participants will want to keep a close eye on labor and inflation data in the coming months. As we noted last quarter, the labor market is the last domino holding up the economy. It has started to show some signs of a wobble (initial jobless claims rising and job openings are dropping), but as long as it stays standing, the Fed’s Goldilocks dream still has a chance of working out.
