Why the likelihood of a recession just increased after Powell addressed Congress

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Thursday, March 9, 2023

Today’s newsletter is over Jared Blikre, a reporter focused on the markets at Yahoo Finance. Follow him on Twitter @SPYJared. Read this and more market news on the go with the Yahoo Finance app.

Fed Chairman Jay Powell just poured cold water on the “no landing” crowd in hopes of staving off a US recession and taking stocks to new all-time highs this year.

After two days of grilling before Congress, investors have been reminded (again) that the Fed chief still sees inflation as a lingering, pernicious threat.

Equities and bonds rallied on Wednesday as both sold off on rising short-term interest rates, dragging major indices from the end of the week.

“If the totality of the data indicates that faster tightening is warranted, we would be willing to step up the pace of rate hikes,” Powell said before the Senate.

And with two weeks to go until the next Fed meeting, markets are expecting just that. Bonds and derivatives are pricing in a more aggressive performance – expecting the Fed to raise its benchmark rate by 50 basis points instead of 25 basis points.

Since Monday’s settlement, US 2-year Treasury yields are up 18 basis points to 5.06%, the highest level since 2007. It also deepened the inversion against the 10-year yield, with the spread widening a negative 108 basis points (or -1.08 percentage points) – the highest since the early 1980s, when Paul Volcker was chairman of the Fed and was fighting a similar battle over price inflation.

Under normal circumstances, interest rates on longer-term loans or bonds (the cost of money) are expected to be more expensive than their shorter-term counterparts, as the long-term risk is greater. But this changes when the Fed starts eradicating animal spirits, raising short-term interest rates to limit credit creation and ultimately stifle growth.

While the size or depth of a yield curve inversion is not necessarily predictive of a deeper or longer recession, there are plenty of other indicators in the bond market that are ringing alarm bells.

Former bond trader and CEO of TheMacroCompass.com Alfonso Peccatiello recently joined Yahoo Finance Live to offer his insights.

Peccatiello notes that the bond market expects the Fed to fight inflation and remain tight, with interest rates well above 5% per annum. “That can’t happen when a recession is underway. The Federal Reserve will be forced to cut interest rates,” he said.

Essentially, the inflation-fighting credibility that Powell has earned in the markets comes at a cost – driving Fed capitulation expectations far beyond what has happened in the past.

“The problem is – the tighter you enforce private sector lending terms, the higher you keep mortgage rates, the higher you keep corporate lending rates – the more likely you are to freeze these credit markets and essentially sleepwalk into an accident. or, in general, precipitate a recession later on,” Peccatiello said.

But long before the Fed brings relief in the form of spending cuts, Peccatiello expects stocks to suffer an earnings recession, which he says is “not fully priced in”. (An earnings recession — characterized by two consecutive quarterly declines in S&P 500 earnings — often, but not always, precedes an economic recession.)

Peccatiello believes the US is already in an earnings recession and that the stocks reflect complacency. Still, he doesn’t expect disaster. He sees maximum downside risk of about 10% in the S&P 500 all the way to the 3600 level, which is around last year’s lows.

“I don’t think it will be much lower,” he says, adding: “[T]The stock market generally bottoms out before earnings bottom out.”

The Fed’s rate cuts are then fed into better stock valuations, which ultimately halt the fall in stock prices, Peccatiello added. “[This] means the stock market can halt the downturn and slowly but surely enter a new bull market.”

What to watch today



  • Ulta Beauty (ULTA); Allbirds (BIRD); American outdoor brands (AOUT); BJ’s Wholesale (BJ); DocuSign (DOCU); Fuel Cell Energy (FCEL); Gorge (GPS); JD.com (JD); National Drink (FIZZ); Smith & Wesson Brands (SWBI); Vail Resorts (MTN); Zumiez (ZUMZ)

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