According to George Cervelos, global head of currency research at Deutsche Bank, there was some major change in the market following Thursday’s US consumer-price index report.
Based on moves in US stocks SPX, -0.18% and US dollar EURUSD, -0.35%, which gained parity with the euro on Thursday, Cervelos said in a note to clients on Thursday that the market is now pricing in 100% hurdles. are doing. Before the end of the year, the US economy will go into recession.
Using the peak in the fed funds futures curve as a proxy for bearish expectations, Cervelos pointed out that market views on the timing of the start of the next recession have changed substantially from February, when investors are expected to arrive in December. were ready for recession. 2024. By Thursday, it had shifted to January 2023.
Source: Deutsche Bank
According to Cervelos, this change is a sign that recession risks have replaced inflation as the most important market factor.
Given this, there are a few factors that investors should keep in mind.
- Beware of the labor market. Cervelos said weak demand coupled with strong labor markets is a recipe for lowering productivity and profit margins. This can be especially negative for riskier assets. But a turning point in the labor market will be needed before the Federal Reserve and other global central banks can begin the transition to cut interest rates.
- Keep an eye out for bubbles. The longer central banks maintain strict monetary policy, the greater the risk of leverage. Scandinavia is particularly exposed to leverage, Cervelos said.
- Beware of history. Markets are pricing the start of an aggressive easing cycle from the Fed next year, which makes sense given that economic growth began to slow as central banks, over the past three decades, did. However, the inflation problem has been around for a long time. Saravelos noted that during the 1970s, when inflation remained the same for nearly a decade, the US price-to-income ratio fell from 20 to 7. As of Thursday, the forward price-to-earnings ratio for the S&P 500 was approximately 16.01. According to FactSet data.
Fed funds futures are expecting the first Fed rate cut to come next summer. Of course, as long as inflation persists, the Fed will keep monetary policy tight until a dramatic economic downturn forces the central bank to surrender.