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Recession Risk Rises as Stocks And Bonds Slide  Thumbnail

Recession Risk Rises as Stocks And Bonds Slide



Economists are forecasting softer economic growth, perhaps leading to a recession at some point in the near term. "The next couple of years will be bumpy ones for the economy, with high inflation and slower growth," says PNC Chief Economist Gus Faucher. "The likelihood of recession in the U.S. is now about 30%, up from 15% before the Russian invasion of Ukraine."

Stock and bond markets continue to reflect these risks. The previously soaring S&P 500 Index, a popular measure of American shares, fell nearly 9% last month and is essentially flat for the trailing one-year window. Meanwhile, U.S. bonds continue to sink as the market recalibrates for higher interest rates for the foreseeable future (bond prices and yields move inversely).

Prices for raw materials were clearly the upside outlier last month. The spot return for the S&P Goldman Sachs Commodity Index (GSCI) surged nearly 50% in April. The ongoing Ukraine war is a key factor. From sanctions on Russian crude oil to the loss of wheat and other agricultural exports from Ukraine to years of under investment in production elsewhere, a supply-side shock continues to ripple through commodities markets worldwide.

Inflation is a contributing factor for the rally in commodities. The one-year change for the U.S. Consumer Price Index (CPI) reached a 40-year high in March. The 8.5% increase topped February’s 7.9% by a substantial degree, raising new questions of when pricing pressure will peak.

Meanwhile, the Federal Reserve is expected to continue raising interest rates for much of the year in a bid to cool inflation. Fed funds futures are currently pricing in a high probability that the central bank’s target rate (currently at a 0.25%-to-0.50% range ahead of the May 4 FOMC meeting) will end this year at 3.0%-plus.

Although risk has clearly increased for the economy, there’s still debate about how far and how fast growth will slow and when a recession might start. Pessimists point to the 1.4% decline in gross domestic product (GDP) in the first quarter as a warning flag.

The slide surprised economists, who were expecting a modest gain for GDP. But it is important to note that the Q1 contraction is due to technical factors, brought on by a surging trade deficit. By contrast, the main engine of the economy – consumer spending – picked up.

Overall, “the domestic economy actually heated up in Q1,” writes Gregory Daco, chief economist at EY-Parthenon and a former board director at the National Association of Business Economics.

That said, recession risk is growing, according to the ISM Manufacturing Index, a survey-based estimate of U.S. manufacturing activity. The benchmark eased to its slowest pace in over 1-1/2 years. But the 55.4 reading is still well above the neutral 50 mark.

"Manufacturing should continue to add to GDP growth but the breadth of growth has narrowed," says Ryan Sweet, a senior economist at Moody's Analytics. "Risks to the near-term outlook remain weighted to the downside because of the Fed's aggressive tightening cycle, financial market conditions and geopolitical conflict."