Well it’s December and that means holiday parties, letters in your mail you’ll actually want to read (especially the ones for the kids with a H0H0H0 postal code) and most importantly time with friends and family you may not have had the opportunity to see so far this year. For markets it would appear that the holidays arrived earlier this year given the gift Jerome Powell gave on Wednesday stating, “…it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.” These two sentences cemented in the minds of stock traders in the U.S and abroad that the U.S. Federal Reserve will hike the overnight lending rate by 50 basis points, signaling a slow-down in the pace of rate hikes.

 

As many business analysts and market pundits have stated over the last several days, the Federal Reserve board members’ words, especially those of Mr. Powell, have been over-analyzed to the nth degree this year. Equity markets are always looking for good news, especially in this post-COVID environment we now find ourselves in with newer global economic challenges ahead. However, there is more to the market sustaining a positive uptrend than the direction of interest rates – albeit it remains a key focus given inflationary pressures are still far greater than they traditional have been for our modern global economy to sustain itself effectively.

 

This is why it’s important to look at the big picture, not just one piece of information. Let's review the risk of recession in the U.S. in particular and how we see the coming months unfolding given the available data today.

 

(1) The Yield Curve

As of the date of writing this note, the yield on a 1-year U.S. treasury note is 4.77% and on a 10-year note it is presently 3.58% - reflecting an inversion of 1.19%. (As of 10:15AM December 2, 2022) Historically yield curve inversion occurs approximately 12 months before recession, which began in in July – however 6 months ago the inversion had already begun but it was much more muted at a differential of 0.39%. U.S. banks have also begun to tighten their lending criteria and policies, as have banks here in Canada and abroad indicating market capital may certainly be tightening. If you’re a business in need of credit, right now you pay a heavier price and that impacts profitability and opportunity for growth.

Source: FactSet Interest Rates, Tullett Prebon Information, *SWX Swiss Exchange

 

(2) ISM Purchasing Managers Index

This has been negative since May, but relatively stable.  In the month of November it showed it dropped by 1.2 points to 49, which is indicative of economic contraction. Frankly it is a survey so it is more subject to human error than other indicators. That being said, historically it has always preceded a U.S. recession and is a good support indicator when other metrics begin to reflect a recession is coming. 

 

(3) The U.S. Conference Board Leading Economic Index (U.S. LEI)

November data is still yet to made available, however October data reflected a 6 month decline of 3.2%. When the U.S. LEI has been negative relative to the previous year, which is the case in 2022, this has always preceded a U.S. recession at least over the last 25 years. You’ll note the decline in the index is similar behaviorally to more traditional recessions such as the one in 2000 and 2008, given 2020 was a much more anomalous event.

Unemployment still remains fairly robust and as of this morning the U.S. unemployment rate showed to hold steady at 3.7% in the month of November.  This was expected, what was not expected was the U.S. adding 263,000 jobs over the same month, as the general consensus was an increase of 200,000.  There remains the possibility that this could cause the Federal Reserve to reconsider their position on a 50 basis point rate hike, however the real data point that they will be looking at is inflation and that figure will not be available until December 12th.

 

In sum, the U.S. economy certainly appears to be moving towards recession in the early half of 2023, perhaps as soon as the first quarter if financial conditions tighten or there is a more significant impact to corporate earnings and valuations.  It is quite clear that the U.S. moving into recession isn’t a question of if, but a question of when.