PIMCO: Not Inevitable
This is the language of choice for central bankers these days when talking about the chance of a recession. That will, of course, do very little to reassure markets, especially when the number one objective is squarely inflation and it is way too high. Central bankers around the world are in a hawkish run, with a synchronization and to an extent that has probably never been witnessed before. Last week saw some well-telegraphed hikes by the U.S. Fed (50 bps), Bank of England (25 bps), Brazil (100 bps), Poland (25 bps), Colombia (100 bps) and Chile (125 bps), but also a couple of surprise increases from the Reserve Banks of Australia (25 bps) and India (40 bps), on the back of a surprise hike from Sweden’s Riksbank the week prior. Meanwhile, the hawkish rhetoric at the European Central Bank (ECB) has exceeded all expectations and a large number of board members have all but sealed a rate rise for June or July, earlier than previous expectations for an autumn hike. In fact, markets now predict four hikes from the ECB by the end of 2022.
Naturally, rates are on the rise everywhere: the U.S. 10-year Treasury yield has crossed the 3% mark and is back to December 2018 highs; the German Bund crossed 1% for the first time since 2015 and UK Gilts crossed the 2% mark; the benchmark U.S. 30-year mortgage rate reached 5.5%; and the spread of the 10-year Italian BTP is at 200 bps vs. the Bund, while the real yield on 10-year U.S. TIPS is in positive territory. The corollary is that asset valuations have to adjust downward as rate expectations continue their march higher. The question becomes, “will this march higher in rates in a bid to tame inflation tip economies into a recession?”, since this could affect risk asset valuations in a more meaningful way.
There are arguments on both sides regarding the chances of a recession and it will depend on how stubborn and persistent inflation proves to be. What is certain is that the path to a soft landing has narrowed further, which was obvious during the press conference from Fed chairman Powell: “there is a path to avoid a recession”, “it is not going to be easy”, “will be challenging” and we only got a promise of a “soft-ish” landing. But the real surprise of last week came the next day, when the Bank of England forecasted negative growth for 2023 in the UK. The bank had been early to the hawkish party with a rate rise back in December 2021, but it is already warning of an “unprecedented squeeze on household revenues” pushing the economy into stagnation. Further, while “most members still judge that some further tightening might be appropriate”, this means that not all of them do. The Bank of England’s assessment came as a cold shower and a reminder that recession probabilities are inevitably rising. Will the Bank of England be the canary in the coal mine? This is what markets will be watching.
Source: By Geraldine Sundstrom, Asset Allocation Portfolio Manager at PIMCO