The Weekly Wire: Recession Watch - Revisited
Despite initial optimism about the US economy in 2022 amid high inflation and geopolitical tensions, recent historic inversion of the critical 3 Month Bill to 10 Year Note yield curve segment and other economic indicators now signal a likely recession in 2023, though the authors remain cautiously optimistic about rising US stock and bond prices due to improved sentiment, valuations, and a potentially more dovish Federal Reserve.
Despite historically high inflation, a very hawkish Fed, still snarled supply chains and the ongoing events in Eastern Europe, we remained more optimistic than not on the US economy as we moved through 2022. This point of view has largely been proven correct. While GDP contracted by 1.1% during the first half of 2022, GDP expanded by 2.9% in Q3, and the economy is heading into year-end on reasonably solid footing.
Six weeks ago, we published a Weekly Wire titled “Recession Watch,” making the case that an economic downturn had become more likely. To provide context, an inverted yield curve is a historic harbinger of a US recession. However, not all parts of the curve are equally predictive. Into late October, the US 2 Year Note to US 10 Year Note part of the yield curve had been inverted for some time, but the US 3 Month Bill to US 10 Year Note part of the curve (which we consider the most important for economic forecasting) had not inverted. Then, in late October, the US 3 Month Bill to US 10 Year Note part of the curve did invert, prompting us to write our “Recession Watch” note.
As we move into mid-December, the US 3 Month Bill to US 10 Year Note part of the curve is inverted by approximately 85 basis points, the most ever. A US recession is not pre-ordained, but the yield curve and other key indicators, including money supply and The Conference Board Leading Economic Index, point in that direction. While we are cautious on the outlook for the economy next year, we are optimistic on the outlook for US stocks and bonds, believing sentiment, valuation, and a more dovish policy posture at the Fed should support higher prices for both asset classes as we move through 2023.