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Economic reports in the first half of 2023 generally painted a grim picture, with many indicators posting declines similar to those seen heading into past US recessions.
An inverted US Treasury yield curve—with shorter‑term yields higher than longer‑term yields—is one of the warning signs that historically has signaled a downturn, Page notes. At the end of May, the yield on the three‑month Treasury bill was 188 bps higher than the yield on the 10‑year Treasury note—just below the all‑time record set earlier in the month.
But those recession warnings could be misleading, or at least incomplete, Page argues. In many cases, the sharp declines seen in such measures as purchasing managers’ indexes, consumer confidence, and the US money supply have been from the inflated levels reached during the pandemic and its aftermath. “A lot of these indicators are flashing red because we’re still unwinding COVID distortions,” he says.
During the pandemic, Page notes, household savings soared as stimulus measures poured money into consumers’ bank accounts faster than they spent it. Now those balances are coming down. But they remain extremely high by historical standards, and debt service ratios are still low.
In the Fed’s most recent survey of senior bank loan officers, nearly half said they’ve tightened lending standards in the wake of the banking crisis—a level also historically associated with recessions, Page notes. But healthy consumer and corporate finances could mitigate the economic impact of tighter credit. “The most important difference now is that the balance sheets are in better shape,” he says.
Husain suspects that some financial indicators also could be sending misleading signals about the near‑term direction of central bank policy rates (Figure 2).
Interest Rates May Have to Stay Higher for Longer
(Fig. 2) Central bank policy rates
As of May 31, 2023.
US = Federal Reserve fed funds upper limit. Eurozone = European Central Bank main refinancing rate. Japan = Bank of Japan overnight call rate. Australia = Reserve Bank of Australia official cash rate.
Sources: US Federal Reserve, Statistical Office of the European Communities, Cabinet Office of Japan, Reserve Bank of Australia.
As of late May, Husain notes, interest rate futures markets were forecasting several Fed rate cuts before the end of 2023. He sees that as unlikely, barring a major liquidity crisis and/or an abrupt US plunge into recession.
“I think the market is trying to reconcile two very different scenarios—one where the US economy remains fairly strong and the Fed doesn’t cut rates, and one where things go terribly wrong and the Fed has to cut by several hundred basis points,” Husain explains. “That averages out as what’s priced into the market.”
Near‑term rate cuts are even more unlikely in Europe, Husain adds. In fact, he expects both the European Central Bank (ECB) and the Bank of England to raise rates several times more, despite the economic risks. “I do think the Fed and other central banks will cut rates eventually,” Husain says. “But the timing is tricky. Rates are going to remain higher for longer.”
The Bank of Japan (BoJ) remains an outlier among the key developed central banks, Husain notes, as it still is in quantitative easing mode—including its policy of capping yields on long‑term Japanese government bonds. But this could soon change, he warns.
Arif Husain
Sébastien Page
Justin Thomson
Thinking
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2023 Midyear Market Outlook
Finding the signal through the noise
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