First big Wall Street bank to call for US recession says ‘pessimists will unfortunately prevail’


Deutsche Bank, which became the first major Wall Street bank to forecast a US recession in April, goes through a list of pros and cons for the world’s largest economy that could make a soft landing – and comes to the conclusion that it won’t. .

Henry Allen, a research analyst at Deutsche Bank, wrote in a note issued shortly after Tuesday’s release: Consumer Price Index for August, Which showed the spread of inflation on a larger scale despite the decline in gasoline prices. One of the biggest reasons, Allen said, is that the full impact of the series of Fed rate hikes will not be felt for a year, or until 2023.

Financial markets stumbled after August CPI data, which contained signs of widespread services inflation and came in higher than both economists and traders had expected, with an annual headline rate of 8.3%. Dow Industries DJIA,
-3.94%
It finished down nearly 1,300 points, falling along with the S&P 500 SPX,
-4.32%
and Nasdaq Compound,
-5.16%And the
In what was the worst day for stocks since June 2020. Meanwhile, investors sold most Treasurys, sending a two-year policy-sensitive yield TMUBMUSD02Y,
3.745%
to another high in 2007, and traders boosted their expectations for a massive 100 basis point Fed rate hike next week.

“It is likely that stubborn inflation pressures will force the Fed to increase tension in its tightening campaign, putting the broader economy at risk of a material deflation/recession over the next year,” said Jason Pride, chief investment officer at Private Wealth. in Glenmede, which manages $40.2 billion in assets. “In recognition of these uncertainties, investors should maintain a lower risk-averse stance, particularly given the premium valuations still prevalent in equity markets,” Pride wrote in a note.

In April, Deutsche Bank DB,
-3.54%And the
Headquartered in Frankfurt, Germany, it has become first pioneer Wall Street predicts a recession in the US, citing inflationary psychology that has changed dramatically and long-term expectations that were in danger of falling unfettered. keep seeing Negative risk For her pessimistic view that month, she described herself as a “street extremist.” In June, Deutsche Bank also said it sees an opportunity for this Inflation will fail to slow down.

Below is Deutsche Bank’s list of reasons why the US economy’s sharp decline continues, despite hopes that supply chains and the labor market are beginning to return to normal.

Monetary policy is lagging

The Fed rate hikes are running after a time period of about a year, which means that the bulk of the central bank’s rate hike campaign hasn’t made its way through the US economy yet.

To be sure, interest rate-sensitive sectors like housing are already feeling the effects of higher Fed rates, with the National Association of Home Builders’ market index declining in recent months, and the sales index hanging near one of the lowest levels in Allen’s books in more than a decade. But these effects are expected to become more prominent in the coming months.

Fed officials are still mostly expected to raise their key interest rate target again next week by 75 basis points to between 3% and 3.25%, from the current level of 2.25% and 2.5%. However, traders are now also factoring in a 34% chance of a full percentage point hike on September 21, which would raise the fed funds rate to between 3.25% and 3.5%, up from zero chance seen on Monday, according to it. to me CME FedWatch Tool.

The chart below shows how the Fed’s tightening cycles coincided with a major crisis somewhere in the world.

Source: Bloomberg, Deutsche Bank

tight job market

Optimists often cited a tight US labor market as the biggest reason the world’s largest economy could avoid a downturn, given widespread job availability and continued demand for workers. However, Deutsche Bank’s Allen said an “incredibly tight” labor market would make it difficult to rein in inflation and could “require more rate hikes”.

The number of job vacancies per unemployed worker is just shy of the record reached in March, the research analyst said, and large-scale workforce participation still exceeds just adult workers a full percentage point below pre-Covid levels.

“There is also no precedent for managing a labor market calm by only reducing vacancies without increasing unemployment,” he wrote.

Recession indicators “blink red”

The spread between the 2- to 10-year Treasury yields TMUBMUSD10Y,
3.414%And the
Long seen as a reliable harbinger of a recession, it was flipped for the first time this year in March and remains sharply negative, at -33 basis points on Tuesday after the CPI report.

Allen said that part of the curve has reversed before each of the last 10 recessions in the US, and based on historical averages of how long it takes for a downturn to occur, a recession could hit by the second half of next year.

Inflation outliers

The recent dips in inflation, which gave some hope that higher price gains might turn around, have been driven by what Allen calls “outliers” rather than broad-based moves. This was the case for the CPI in August and July, both of which reflect lower energy prices. Energy prices tend to be volatile anyway and are often left out by policy makers when trying to determine where inflation could head from here.

Conclusions

Based on how far the Fed has deviated from both price stability and maximum employment mandates over time, no soft landing has ever been achieved, according to Deutsche Bank.

“We very much hope we were wrong here, but given the difficulties the economy is set to face into 2023 as the late effects of higher interest rates begin, it will be very difficult to avoid a soft landing,” Allen said. “In particular, the empirical evidence shows that the kind of gentle landing people hope has never happened before from a place like the current situation with inflation well above target and a very tight labor market.”