If it occurs, next year’s recession will be one of the mostly widely anticipated in history. A relatively benign recession is currently priced in. Indeed, credit spreads are narrowing. The OFR Financial Stress Index has fallen back since the ‘peak’ on September 29th.
Real yields have turned lower, sitting below 1.50% across 10- to 30-year maturities. But the New York Fed President has struck a more hawkish tone, warning that the inflation fight could last until 2024. This is repeating the usual pattern of play: financial conditions ease, and this is met by a pushback from the Fed.
The global economy is on a down cycle, however. Apartment prices are now falling 3.66% y/y in South Korea. The decline in Hong Kong residential prices is even steeper, tumbling 14.5% y/y last week.
Disinflationary pressures will now come through faster in the US, aided by the latest fall in gasoline prices.
Average hourly earnings, payrolls, and the core PCE price index could all come in lower than expected this week. Ordinarily, this would suggest putting on curve steepening trades. But the Fed will not let up just yet, given the easing of financial conditions. As such, the Treasury curve may continue to invert (up to -100 bps, 2-30 years).
The 30-year breakeven inflation rate has dropped to 2.27% (which essentially implies zero inflation risk over this duration). Ultimately, markets believe in the credibility of this Fed.
