Stock markets around the world have begun 2023 in buoyant mood. The gloom evident in December has been replaced by a narrative that says central banks are close to ending their tightening cycles thanks to inflationary pressures beginning to abate.
That narrative was given a boost on 1 February when Fed chair Jerome Powell used the word “disinflation” 15 times in his press conference following the decision to raise the Fed Funds rate by 0.25 percentage points to an upper bound of 4.75%.
Several leading indicators of economic activity in the US continue to suggest a recession is probable this year. These include the inversion of the yield curve since October and the extent of the decline in the index of leading indicators. Another measure with a good track record of predicting recessions joined them in January when the ISM New Orders index fell to 42.5.
US ISM New Orders Index and recessions
Source: Waverton
That means three of the best indicators of recessions are at levels where the economy has already been in recession or in one within three months. As has been said when trying to determine an outcome, if it looks like a duck, swims like a duck and quacks like a duck: it is probably a duck.
The economy at the moment looks reasonably healthy. The unemployment rate is now at its lowest level since May 1969. The strength of the labour market data for January has resulted in the market pricing in a higher peak of the Fed Funds rate and a slower rate cutting cycle beginning later this year.
But the market is still expecting that “pivot”, which is a big reason for the stock market (and bond market) rallies this year.
We are struck though by the fact that the US was in recession in December 1969, seven months after the unemployment rate was at the current level.
Overall, we stick to our view that a US recession is likely this year, albeit the longevity and severity of a recession remains the subject of much debate.
Away from the US, the UK and continental economies still look weak even though, partly because of easing energy prices, the depth of recession this side of the Atlantic may be less than previously expected.
The good news too is that the UK the market is now pricing in a peak of 4.25% for the Base Rate, down from the 4.5% expected in recent months. A full cut is also now in the price by the end of the year.
Meanwhile the move away from a zero-Covid policy in China is likely to be a boost to tourism in the rest of Asia and the west. It should also alleviate concerns about manufacturing supply chain disruption as people return to work.
Important to remember though that China’s industrial production is more dependent on global demand than it is on domestic demand, so whether the government can do enough to offset the likely slowdown in the west remains to be seen.
William Dinning is chief investment officer at Waverton. The views expressed above should not be taken as investment advice.