70% chance of recession The Fed’s model prediction for 2024

Historical precedent

1. Great Depression (1929-1933): The most severe global economic downturn in history, triggered by the stock market crash of 1929. It was characterized by massive unemployment, deflation, and social unrest. While unlikely for such a severe depression to occur again due to different economic structures and policy frameworks, this recession highlights the potential gravity of global economic downturns.

2. 2008 Financial Crisis: The bursting of the housing bubble in the US triggered a global financial crisis and a severe recession. Stock markets plummeted, credit markets seized up, and economies contracted significantly. This example showcases the inter connected of global financial systems and how a crisis in one region can quickly spread to others.

3. 1997 Asian Financial Crisis: This crisis originated in Thailand and quickly spread across Southeast Asia due to currency devaluation and capital flight. While it primarily affected the Asian region, it also impacted global markets and highlighted the risks associated with rapid capital flows and currency imbalances.

4. 1973 Oil Crisis: The Arab oil embargo triggered a severe supply shock and significant price increases, leading to stagflation in many economies. This crisis demonstrates the impact of external shocks like energy disruptions on global economic performance.

5. 2001 Dot-com Bubble Burst: The bursting of the tech bubble in the early 2000s led to a decline in technology stocks and a slowdown in economic growth. This highlights the potential risks associated with asset bubbles and excessive speculation.

 Present Situation  

Indicators with track records of predicting recession are reaching some of their worst levels ever.  yield curve that compares interest rates between shorter- and longer-term bonds are one of them.The yield on 3-month Treasury bill versus the 10-year Treasury bond is a popular measure, and the Federal Reserve even maintains a recession probability model based on its level. At one point in 2023, the yield curve was inverted at -1.89%…the largest inversion in at least 40 years as you can see blow to economy 

Trying to assign the likelihood of a recession emerging in 2024 has significant implications. As the Fed looks set to cut rates in the coming year ,the ultimate path of stock prices depends on recession and the impact to corporate earnings. The impact of rate cuts isn’t always positive for the S&P 500. Over the past 40 years, the S&P plunges during cutting cycles if the prior hiking cycle leads to recession.

Stock market sectors that are sending a positive hope on the outlook for both stocks and the economy, like with the performance of semiconductor companies and home builders. We  will continue analyzing the performance of cyclical sectors and what it means for the outlook. But in 2024, we will be watching the high yield bond market closely as well.

                   Companies issuing high yield debt are already on shaky financial ground, and have to issue debt at a higher interest rate to attract investors. The extra compensation that high yield investors demand over a safe asset like a U.S. Treasury bond is the spread, and that spread moves higher or lower based on the probability of being paid back in full from lower quality companies.That means spreads are very sensitive to changes in the economic outlook, and widen when high yield investors grow nervous about getting repaid and narrow when the outlook is positive.

                              Widening spreads lead recessions and tend to lead more significant moves lower in the stock market as well. But right now, spreads are narrowing and are near decade lows . While spreads started moving higher during 2022’s bear market in stocks, spreads stayed contained relative to past episodes that preceded recession and is moving lower throughout 2023.

                       We  also track the relative performance of specific high yield categories. The chart below shows a ratio of “CCC” and below rated bonds to “BB” rated ones going back to the late 1990s. In other words, how are the lowest rated junk bonds holding up with a rising line showing relative outperformance. That line has been rising for most of 2023, and is recently turning back higher. A move to three-year highs would be another positive signal on the economic outlook.

               Along with the message coming from key cyclical stock market sectors, the high yield bond market is not signaling recession fears at the moment. If a growing economy translates to rising corporate earnings, then the stock market should respond favorably if the Fed starts cutting rates in 2024.

Evidence of Slowdown

·         Global GDP growth: Forecasts suggest slower economic growth compared to 2023, with organizations like the IMF predicting around 3.1% compared to 3.4% in 2023.

·         Central bank tightening: Interest rate hikes by major central banks like the US Federal Reserve to combat inflation are dampening economic activity.

·         Geopolitical tensions: The war in Ukraine and ongoing trade disputes continue to create uncertainty and disrupt global supply chains.

·        Energy crisis: The ongoing energy crisis in Europe and potential price fluctuations can further impact economic activity.

current Global Trends:

·         Cautious optimism: While concerns about recession linger, there's also a sense of cautious optimism among investors due to factors like resilient corporate earnings, potential easing of rate hikes in the future, and hopes for a soft landing by major economies.

·         Geographic differences: Sentiment varies across regions. Some emerging markets like China and India show relative optimism due to their relatively strong growth prospects. Developed economies like the US and Europe face greater headwinds but still have pockets of bullishness in specific sectors.

·    Sector rotation: Investors are rotating out of highly valued growth stocks that were hit hard by rising interest rates and shifting towards undervalued sectors like consumer staples, healthcare, and utilities.

Key Metrics for Recession:

·  Equity market performance: While volatile, most major global indices have managed to stay above their year-to-date lows. This indicates some underlying resilience despite anxieties.

· Volatility gauges: VIX index measuring US market volatility remains elevated, although it has come down from earlier highs. This reflects continued uncertainty but potentially a reduced level of panic.

·     Investor surveys: Surveys by organizations like Bank of America and Merrill Lynch show mixed sentiment, with some regions and sectors displaying more optimism than others.

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