With the start of 2023, many are wondering if we'll see a recession or a soft landing in the US economy. Sure, last year's resilience is reassuring, but let's not forget that yield curve inversion has preceded every recession since the 1950s, and right now nearly every yield term spread has inverted. That's a red flag!
But before you go stocking up on canned goods and gold, it's important to note that not every instance of inversion leads to a recession. However, the 2y10y curve, which is a reliable indicator of recession risk, is at its most inverted since the early 80s and has been inverted since early July. That's a pretty strong signal if you ask me. Additionally, other segments of the yield curve, including the 3-month/1-year and 3-month/10-year, are also inverted which typically indicates a high recession risk within a 12-month period.
I know the labor market seems strong, but don't let that fool you. The Federal Reserve is determined to tighten monetary policy until that strength is eradicated and as the saying goes, time is money. And according to economist Mohamed El-Erian, we can expect to see a recession replacing inflation as the driver of the global economy in 2023. This will add a healthy dose of uncertainty for investors and potential market turbulence.
In the past year, we were fixated on inflation and how central banks were tightening monetary policy to slow down the rate of price increases. But it looks like that may have been too little too late. Bank of America and other Wall Street banks warn that central-bank tightening will tip us into a recession and drive stocks down by over 20%. El-Erian has criticized the Fed for acting too slowly and now inflation is spreading to wages and the service sector, stubbornly staying around 4%.
In short, don't let last year's resilience fool you, the inverted yield curve and other market indicators are pointing toward an impending recession. The Federal Reserve's determination to tighten monetary policy means the clock is ticking and investors should be prepared for a wider range of potential outcomes in the global economy. It's important to remember that past performance does not guarantee future results, so let's all hope for a soft landing and not repeat 2008 again.
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