Bets and signals

With major equity indices in correction territory, and the Magnificent 7 stocks in bear market territory, recession fears are back into play. According to polymarket, the probability of an economic recession in the U.S. is 40%. There’s too much debt, which needs to be reduced, and in doing so, it would lower the GDP growth, which has benefited from excessive spending since Covid. On top of that, we have tariffs, which will be imposed on the US major trading partners (Mexico, China and Canada) and will cause friction and higher prices, and we’ll need to see who absorbs them, the consumer, American corporations or the trade partners, by weakening their currencies or else. There are however, two indicators that are not giving recession warning signals yet: the yield curve, and credit spreads. The yield curve is relatively flat between Fed funds and the 10 year yield, but the ultra long end is still positively sloped. Credit spreads are still within historical minimums, and both of them are typically good indicators of recessions. Is it because we’re entering a stagflation period or simply things are not that bad (yet) for them to trade in distress? The Fed will probably give us an official (decaf) answer to that question next Wednesday, and perhaps we’ll be able to determine if the equity market signal is a head fake or a leading indicator.

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