According to recent data released by payroll processing firm ADP, private sector jobs surged by 497,000 in June, coming in at more than twice the expectations and reigniting fears of resumption in rate hikes by the Federal Reserve, which markets have been ignoring during the latest bull run.
Consequently, as the 2-year treasury yield hits a 16-year high amid a broad market selloff, a recent note by Michael Hartnett, chief investment strategist for Bank of America Corporation (BAC), that, rather than seeing a long-lasting bull market, the jump represents a “big rally before big collapse” is seeming more credible than ever.
After ten consecutive and aggressive interest-rate hikes over the past year, the Fed opted for a pause citing concerns regarding economic growth and the need to assess lagged impact of policy.
However, in his remarks to Congress a week after the June 13-14 FOMC meeting, Fed Chairman Jerome Powell said the central bank has “a long way to go” to bring inflation back to the Fed’s 2% goal.
Moreover, according to the meeting minutes, almost all Fed officials concurred to indicate further, albeit slower, tightening as inflation remains elevated at 4.6% and job openings outnumber available workers by a nearly 2-to-1 margin.
Gita Gopinath, first deputy managing director of the International Monetary Fund (IMF), also echoed that central bankers “should continue tightening and importantly [interest rates] should stay at a high level for a while.”
Hence, with pent-up demand for travel and leisure during the pandemic responsible for the expectation-crushing employment numbers, with Leisure and Hospitality leading with 232,000 new hires, it would take irrational exuberance to extrapolate it to perpetuity. With a plausible risk of this tailwind losing momentum, the broader economy could be left high, dry, and strangled with increased borrowing costs.
This could intensify the creeping malaise of defaults and bankruptcies. Corporate defaults rose last month, with 41 in the U.S. so far this year. That’s more than double the same period last year, according to Moody’s Investors Service, which expects the global default rate to rise to 4.6% by the end of the year and 5% by April 2024, higher than the long-term average of 4.1%.
There isn’t much optimism to be found away from home, either. With Chinese recovery after years of strict Covid lockdowns fast losing steam, the slump in the country’s real estate forecasted to last for years, and the government unlikely to pursue an aggressive fiscal stimulus package, it’s unsurprising that global commodities have seen a more than 25% slump over the last 12 months as reflected by the S&P GSCI Commodities index, with Brent crude plunging 34.76% year-on-year despite OPEC’s output cuts coming into play.
Moreover, with the 20-member Eurozone bloc reporting GDP growth of -0.1% for the first quarter, with Ireland, the Netherlands, Germany, and Greece reporting an economic quarter-on-quarter contraction, it is difficult to see where the demand that could make the Chinese manufacturing fire on all cylinders and lift the commodity prices is going to come from.
Amid this general doom and gloom, HSBC Asset Management’s warning that a U.S. recession is coming this year, with Europe to follow in 2024, is gaining credibility with each passing day.
Counterpoint
Financial journalists, including yours truly, are often guilty of propagating expert bias in the psychology of human misjudgment by quoting and referring to (undoubtedly well-meaning) economists, who, just like the fabled Chicken Little, convince themselves and others that the sky is falling with every falling acorn.
However, most economists are conspicuously absent from the Forbes list of billionaires and, perhaps even more conspicuously, have not been able to spot a single recession (including the ones in 1990, 2001, and 2008) since the Philly Fed survey started.
Hence, we could attribute their (of late) misfiring forecasts of the recession that’s always around the corner to the tendency of our flawed human minds to first come to a conclusion and then selectively filter facts that strengthen the argument.
Hence, the fact that a resilient economy has been able to successfully weather Covid-19, the bursting of the crypto and the FTX fraud, geopolitical conflicts, a tech bubble 2.0, supply chain shortages, globalization, banking failures, office vacancies, and higher interest rates (just to name a few), is creating a vacuum of cluelessness that narratives such as “rolling recession” and “richcession” are rushing to fill.
In his book Sapiens, historian Yuval Noah Harari interestingly classified chaos into two categories: First-Order Chaos which is unaffected by predictions about it, such as the weather, and Second Order Chaos, which responds and adjusts to predictions about it, such as economics and politics. Therefore, the fact that measuring and forecasting can change the subject makes the latter category infinitely harder to gauge.
Hence, while it is true that some industries are surely shrinking while the overall economy remains above water and major job cuts have been concentrated in higher-paying industries like technology and finance, it might be the widespread cognition about those phenomena that makes the sinking of the broader economy far less likely.
For instance, the federal government and employers in the hotel, retail, and even railroad industries are seeking to hire people who have been laid off by the tech giants.
Bottomline
Howard Marks, in one of his famed memos, wrote about an impressively obvious reply he usually provides whenever he is asked whether we’re heading toward a recession: whenever we’re not in a recession, we’re heading toward one.
However, nobody has any clue when exactly we will bump into one.
Hence, rather than being generals who are good at fighting the last war by building models that incorporate previous problems while being constantly blindsided by new issues, being diligent investors confident enough to increase their stakes in fundamentally strong business when Mr. Market wants to sell his way out could be a time-tested method to navigate the madness.
