The economic consensus now sees a rising risk of recession in the US with a reducing risk in the UK and the eurozone. This is a big change from the start of the year when the probability of recession in the next 12 months was put at a remarkable 90% in the UK, 80% in Europe and 60% in the US.
Last week saw a dramatic jump in US initial unemployment claims and in the past such a move has been followed by recession. But it seems that the move reflects fraud in Massachusetts and research by Deutsche Bank suggests the upward trend in claims so far this year disappears if you adjust for these fraudulent claims.
In addition, fears by many – myself included – that the problems in US regional banks would lead to a credit crunch were contradicted by other data last week. Both the Fed’s survey of senior loan officers and the small business survey showed no decline in the availability of credit. Indeed, they showed the opposite.
So are economists wrong about the risk of recession in the US? Not in my opinion, and I’m sticking with the forecast of a US recession by year-end. A credit crunch may have been averted but a squeeze is still underway. Credit may still be available, but the terms are much more onerous with rate hikes having an impact. Borrowers are cutting back on demand for credit and consumers are running out of steam. Last year they drew down heavily on their Covid piggy banks but there are signs this support has stopped. We will get more information on the outlook for consumer spending this week with retail sales numbers and earning reports from Walmart and Home Depot.
If the US goes into recession by year-end, will the UK and Europe follow suit? I think the economic data will continue to improve in Europe and the UK over the balance of this year. Consumer confidence in both is improving as energy prices fall and this could result in increased spending. We will also likely see these trends replicated in businesses.
So, what does all this mean for financial markets? US recession probably means falling US equities and given the prevailing bearish mood across analysts and investors alike, any decline should be modest. But equites are likely to underperform in the US relative to Europe and the UK. Second, US interest rates should be falling by the end of the year, even if they go up further first. This means that last week’s bounce in the dollar should prove temporary. Finally, after some wobbles US bonds should rally.
