Michael Hartnett, Bank of America’s top global strategist, believes a no-performance scenario is the most likely outcome for the U.S. economy in the coming months. This means the labor market will remain strong, while inflation will remain above the Federal Reserve’s long-term goal of 2%.
That’s fine for now, but Hartnett warns that this is a path that will ultimately lead to problems for the economy and stocks. The longer inflation stays high, the longer the Fed will have to maintain restrictive policy and then tighten even more, as business and consumer borrowing and spending will slow. , the economy will be at risk of recession.
“Increased risk of non-landing = increased risk of hard landing,” Hartnett said in an April 11 memo. “As monetary tightening resumes (markets are currently pricing in a 15% chance of a Fed rate hike), contagion risks emerge from REITs, regional banks, and small-cap investments.”
From many perspectives, the U.S. economy looks strong. The unemployment rate is historically low at 3.8%, and monthly employment growth is stable. Personal consumption, which accounts for about two-thirds of the US economy, also remains strong. Household balance sheets are also strong, home prices are at record highs, and stock prices are hovering just off record levels.
But some cracks are starting to show. Credit card and auto loan delinquencies are on the rise, and there are more announcements of layoffs. As Mr. Hartnett pointed out, small business employment plans are at an eight-year low, and there is little optimism among small businesses. This is concerning because small businesses make up two-thirds of the U.S. labor market.
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Another sign that the economy could be headed for trouble is the sudden drop in high-yield bond prices in recent months. High-yield bonds have a higher risk of default, so investors seek higher yields in volatile economic environments. When bond prices fall, yields rise.
The iShares iBoxx Dollar High Yield Corporate Bond ETF (HYG) just hit its 200-day moving average, which Hartnett called “spooky.” The fund’s price fell below its 200-day moving average in 2020 and 2022, when the economy slowed and stock prices underperformed.
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This could be a signal that stocks are trending down while the S&P 500 is near all-time highs.
Hartnett said there are other signs that the stock could be entering bubble territory. For one thing, the tech-heavy Nasdaq index is rising at the same time as the 10-year Treasury yield, something that has historically only happened during bubbles or economic recoveries.
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Are we headed for a hard landing?
The market consensus is shifting from a hard landing in 2022 to a soft landing in 2023 and 2024. However, similar to Hartnett’s view, the outlook could start to lean toward a bearish scenario in the coming months, with the Fed likely to keep rates on hold for a longer period of time.
Investors had expected in December that the central bank would cut interest rates for the first time in March. However, with strong employment data and inflation above 3%, the Fed is expected to cut interest rates in July. There are also voices denying the overall reduction in 2024.
“We are firmly in the no-rate-cutting camp in 2024,” Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, said in a note Thursday. “Although unlikely to happen, there is a strong case for the Fed to raise rates in 2024, given rising inflation, low unemployment, high stock prices, the sharp rise in Bitcoin, and the re-emergence of IPOs. It actually exists.”
Geopolitical tensions are currently on the rise as conflicts continue between Ukraine and the Middle East. This has caused oil prices to soar since December and threatens to reignite global inflation.
But despite post-pandemic geopolitical and monetary policy risks, the U.S. economy has so far managed to avoid recession, proving bearish forecasters wrong.
This may happen again in the future. But, as Hartnett argues, the longer a default scenario with high inflation persists, the greater the risk of a recession and bear market.
