Author: Denitsa Tsekova, Bloomberg; Translated by: Tao Zhu, Golden Finance
Financial markets are signaling a higher probability of an impending recession as market turmoil briefly sparked panic on Wall Street last week.
That’s still a small chance. But models from Goldman Sachs Group Inc. and JPMorgan Chase & Co. show the market’s implied odds of a recession have risen sharply, based on signals from the U.S. bond market and the performance of stocks, which are extremely sensitive to the ups and downs of the business cycle.
Goldman Sachs said stock and bond markets are pricing in a 41% chance of a U.S. recession, up from 29% in April. The latest rally has been driven by bets that the Federal Reserve will cut rates at a more aggressive pace and by underperformance in stocks, which are extremely sensitive to business cycle swings. A similar model from JPMorgan Chase & Co. calculated that the odds of a U.S. recession have risen to 31% from 20% at the end of March, due to a sharp repricing of Treasuries.
JPMorgan Chase & Co. strategist Nikolaos Panigirtzoglou said recession risks in the bank’s model reflect the size of rate cuts that have been priced in since last month’s jobs report showed slower job growth. He said the stock market is signaling only a one-in-five chance of a recession, though that’s up from the zero percent probability priced in when stocks hit new highs earlier this year.
“U.S. credit and equity markets look disconnected from U.S. interest rate markets,” he said. “If the next U.S. household survey in August is as weak as the July survey, reinforcing the recession narrative, then equity and credit markets would need to weaken substantially to catch up with interest rate markets.”
Markets are suggesting the chances of a U.S. recession are rising, with a Goldman Sachs financial markets model showing a 41% chance of a slowdown.
The probability of a U.S. recession in the coming year
Weaker-than-expected job growth data released on Aug. 2 raised concerns that the Federal Reserve waited too long to start easing monetary policy, sparking fears of a slowdown. While the data showed a decline in employment, monthly payrolls remained above 100,000, and various indicators of economic health did not warn of an imminent recession. For example, U.S. small business optimism rose to its highest level in more than two years in July.
Moreover, economists’ forecasts have not increased materially, with the consensus forecast remaining at 30% since April and reaching nearly 70% in 2023.
The likelihood of a recession has increased across asset classes
The S&P 500 is still down more than 4% since its mid-July record high, while the tech-heavy Nasdaq 100 is down more than 8% from its peak.
Rate markets are pricing in a recession more than stocks, according to models from Goldman Sachs and JPMorgan Chase & Co. The implied change in the Federal Reserve’s benchmark rate 12 months out implies a 92% chance of a recession next year, according to Goldman’s model, while the change in five-year Treasury yields suggests a 58% chance of an economic slowdown, according to JPMorgan.
Still, there are plenty of reassuring signs in the credit and mortgage markets, and risk levels are not causing too much concern.
Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs, said that while its market models have increased the odds of a downturn, the firm’s economists only put the chance of a downturn at 25%, “which is still relatively low.”
