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Only rates markets are pricing in recession


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Who’s afraid of the bond market?

US rates are flashing stronger recession signals, even as risky markets have gone on a tear. As we flagged Monday, about 130bp of US rate cuts are now priced into interest-rate derivatives markets for next year. That pace of monetary-policy easing looks less like “adjustment cuts” to reflect slower inflation, says Goldman Sachs in a Thursday note, and more like “recession cuts”.

Despite that — and the classic recession-warning sign of a yield curve that has been inverted for more than a year — the bank’s economists say they don’t expect a downturn next year. And apparently, neither do investors in the risky markets that have rallied in recent weeks. The Nasdaq Composite is up 13 per cent from its late-October low; cyclical stocks’ performance have caught up with their defensive peers; and the yield gap between the junk-bond market and Treasuries has narrowed significantly.

In fact, cyclical stocks are faring better even while manufacturing surveys remain weak, as GS points out:

Is it good when those two lines are so far apart?

In other words: Risky markets are reflecting recession-speed rate cuts but no actual recession.

GS, for its part, says it thinks that the Fed won’t cut more than 75bp without a more substantial slow down in economic growth.

That provides a “challenge” to any “sustained positive outlook for markets”, economists add:

On the markets side, we have flagged two important challenges to translating our benign macro view into a sustained positive outlook for markets. The first was valuation, given that market pricing was already closer to our more benign view than to consensus; the second was that, given our more optimistic view on US growth, the Fed could be slow to cut rates. Both challenges are in focus again, making the market more vulnerable to setbacks. Markets have quickly moved further towards pricing our more benign view, and while we anticipated that a weak version of the “Fed put” could support markets, that support was conditional on growth weakness, which is not yet apparent. These are not reasons to switch to a cautious view or to be short, but they argue for using current levels of low equity volatility to add hedges that allow investors to stay long or add risk on pullbacks.

They’re not bearish, mind you, but they say investors should maybe not YOLO into shitcoins Bitcoin st0nks stocks, and consider hedging instead.

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