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This is the most anticipated recession ever. Maybe it is so anticipated that firms and households are so prepared for a slowdown that we may end up not having a recession.
There are two important reasons why we could get a soft landing:
- Corporate profit margins are near all-time highs, and corporate cash balances are near record-highs, which gives companies room to absorb declines in demand without having to lay off workers, see the first chart below.
- Consumers have record-high savings, which means that households will still have money to support consumer spending even if the unemployment rate starts rising, see the second chart.
The bottom line is that we could get a soft landing because both firms and households have significant buffers to deal with a negative hit to demand and incomes.
The implication for markets is that once the Fed pivots from hawkish to dovish, either because of inflation rolling over or growth slowing, credit markets and stock markets could move higher. The next data release to watch is the employment report this coming Friday, where the consensus currently expects nonfarm payrolls at 275,000, unemployment at 3.6%, and average hourly earnings at 5.1%.
Any softening in the labor market and, in particular, in average hourly earnings would push the Fed in a more dovish direction because it would mean that the Fed has finally succeeded in slowing down the economy and ultimately inflation.
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Core CPI inflation for May was 6.0%, and the Cleveland Fed expects core inflation over the coming months to decline to 5.7% and 5.8%, see link here and the first table below.
The Fed’s forecasts for month-over-month inflation are also expected to decline over the coming months, in particular for headline inflation, see the second table below.
The June CPI release will come out on Wednesday, July 13.
See important disclaimers at the bottom of the page.
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Fed: What Is Corporate Bond Market Distress?
https://libertystreeteconomics.newyorkfed.org/2022/06/what-is-corporate-bond-market-distress/The Subjective Inflation Expectations of Households and Firms: Measurement, Determinants, and Implications
https://docs.iza.org/dp15391.pdfECB: Organisational structure as a driver of mergers and acquisitions in the European banking sector
https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2674~ebe571e288.en.pdfSee important disclaimers at the bottom of the page.
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Our slowdown watch is available here, and a major theme in markets this week continues to be the divergence between rates markets and equity markets. Rates investors have been downgrading growth expectations, whereas equity investors have been upgrading earnings expectations. Either rates investors are right, and we will have a recession, and then earnings will come down. Or equity investors are right, and we will have a soft landing, and GDP growth expectations will be revised higher.
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Looking at ETF flows shows that retail investors are taking money out of IG, HY, and loan ETFs but adding money to long crypto ETFs, see charts below.
Source: Bloomberg, Apollo Chief Economist (Note: bito US equity: Crypto ETF flows, BFFUEBK Index: US Bank loans ETF flows, BFFUEHY Index: HY ETF flows; BFFUEIG Index: US IG ETF flows) See important disclaimers at the bottom of the page.
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Electricity prices in Germany are ten times higher than pre-pandemic levels, and the strong increase in European power prices is driven by less wind than expected, worries about the winter balance, and Germany trying to fill the Russia supply gap for natural gas, see chart below. This stagflation theme of higher inflation and lower growth is more pronounced for Europe than the US.
Source: Bloomberg, Apollo Chief Economist 
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Inflation is the number one worry for markets and any signs of inflation coming down could trigger a rally in the stock market and credit markets. The arguments for inflation coming down are accumulating:
1) Commodity prices are trending lower
2) With China reopening and supply chains normalizing, transportation costs for goods are coming down
3) Inventories are growing at many retailers and this is putting downward pressure on goods prices
4) Rising car production is putting downward pressure on new and used vehicle prices
5) Airline ticket prices have been falling during June, see also here
6) Increases in rents and home prices are moderating
7) A higher dollar is lowering import pricesInflation rolling over would also dampen recession worries because lower inflation would mean that the Fed doesn’t have to increase interest rates as much.
The bottom line is that inflation may stay elevated for another month or two, but given the trends listed above, the probability is rising that inflation going into the second half of this year could come down faster than the market currently expects.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Despite central banks globally raising rates, there are still no signs of a slowdown in daily global flight activity, see chart below.
See important disclaimers at the bottom of the page.
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Pedestrian traffic in Times Square is now 94% of pre-pandemic levels, see chart below.
Source: timessquarenyc.com, Apollo Chief Economist See important disclaimers at the bottom of the page.
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This new Fed paper looks at the sources of inflation and finds that demand factors are responsible for only one-third of the increase in inflation. With supply disruptions easing, we should, over the coming months, begin to see a meaningful decline in inflation even if aggregate demand remains solid. Note also in their chart below how demand-driven inflation (=the blue bar) has already peaked. This is very important for credit and equities because what we are waiting for in markets is for inflation to start to decline from its current peak at 8.6%.
Fed: How Much Do Supply and Demand Drive Inflation?
https://www.frbsf.org/wp-content/uploads/sites/4/el2022-15.pdf
See important disclaimers at the bottom of the page.
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