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The market is pricing that the Fed will begin to cut rates in the first quarter of 2023, and I think that view is correct. With inflation expectations well-anchored the Fed doesn’t need to keep the Fed funds rate elevated for several years the way it did in the early 1980s, see chart below. With reference to the dual mandate, the Fed will later this year begin to talk about how the downside risks to growth are intensifying, and those recession risks will ultimately outweigh the shrinking upside risks to inflation.
Source: FRB, BLS, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Why does your company not need to borrow money in the next 12 months? That is a question in the latest Fed/Duke CFO survey below, and 80% of companies respond that they don’t need to borrow because they have enough cash on their balance sheets. Only 10% of companies think that interest rates are too high. For more see here.
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European high yield spreads have been trading wider, driven by intensifying recession risks, but European equity implied vol has remained relatively subdued. The outlook for Europe is very worrying, and either equity vol has to increase or high yield OAS has to narrow, see chart below.
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Blanchard and Summers: Bad news for the Fed from the Beveridge space
https://www.piie.com/publications/policy-briefs/bad-news-fed-beveridge-space
Just How Big Are Federal Interest Payments?
https://www.crfb.org/blogs/just-how-big-are-federal-interest-payments
Fed: The Increase in Inflation Compensation: What’s Up?
https://www.frbsf.org/wp-content/uploads/sites/4/el2022-18.pdf
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Inflation this week came in higher than expected at 9.1%, but the list of reasons why inflation will soon be coming down keeps growing, see below. Our weekly Slowdown Watch with daily and weekly indicators for the US economy is available here.
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We have built a model where oil prices are explained by US supply, OPEC supply, World consumption, and lagged oil prices. All variables are statistically significant. With slower economic growth ahead and supply increasing, the model currently forecasts that oil prices will decline over the coming 12 months, see chart below.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Since employment declined by 22 million jobs during the pandemic, about 21.5 million jobs have been created. But the distribution of the jobs created has been uneven, with some sectors today having employment above February 2020 levels and others having employment levels below. Most noteworthy was the fast recovery in the goods sector and the current strong growth in jobs in the economy’s service sector. The table shows the level of employment in different industries with February 2020 = 100.
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IG index duration has been declining, and HY index duration has been increasing, see charts below. If inflation starts to come down over the coming months as the consensus expects, this shift has important implications for the expected performance of IG relative to HY in case 10-year rates rally from 3% down to, say, 2%.
Source: Bloomberg, Apollo Chief Economist. Note: The measure used is modified duration, which measures the expected change in a bond’s price to a 1% change in interest rates. 
Source: Bloomberg, Apollo Chief Economist. Note: The measure used is modified duration, which measures the expected change in a bond’s price to a 1% change in interest rates. See important disclaimers at the bottom of the page.
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In this PDF we have re-drawn all our charts for credit spreads and yields going back in time as far as possible, and the bottom line is that the ongoing spread widening is still relatively modest seen in a historical context, see also charts below.
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To get a sustained rally in credit markets and stock markets, we need to see:
1) evidence that inflation is coming down for 2-3 months from its current peak at almost 9%, and
2) evidence that we will have a soft landing and not a hard landing.
Stock markets and credit markets will continue to sell off and volatility will remain high as long as there is uncertainty about when inflation will start to decline and whether we will have a recession or not.
We discuss this outlook in this PDF, in our latest podcast on Spotify, and my Monday morning 5-minute Weekly Brief videos.
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