A place of speculation, but also of anticipation, Wall Street has seen its major indices exceed the bar of 10% loss since the beginning of the year. The New York benchmark, the S&P 500, even suffered a third straight weekly decline last week. The word “recession” has been added to an already long list of concerns.
On Friday, the losses posted by the S&P 500 since January were at -10.6%. It was -14% for the Russell 2000, more sensitive to economic conditions, and 11% for the major technologies that make up the Nasdaq 100, rather sensitive to rising interest rates.
These declines are fueled by fears of a more forceful intervention on key rates by a Federal Reserve engaged in a difficult normalization of its monetary policy in the face of inflation that is surprisingly vigorous and persistent. The Fed indicated last week that it would have to move to the rate of increases of at least 50 points in its target rate, and this, more than once, to try to change the trend. For many analysts, the desired soft landing is giving way to an increased probability of recession in this difficult inflation-unemployment trade-off.
The risk of persistent inflationary growth clinging stubbornly above 3%, far from the target, has become omnipresent in the discourse of central banks. In the Beige Book of the Fed’s March, the fear of a wage-price spiral was fully apparent. The strong surge in inflation is combining with a return to full employment to put upward pressure on wages, as distortions in supply chains put upward pressure on prices. The emergence of a wage-price spiral could support maintaining inflation outside the central banks’ target.
It all comes as the markets have to contend simultaneously with three bubbles — in the equity, bond and real estate markets — inflated by low interest rates, abundant savings and the massive injection of central bank liquidity observed during the pandemic.
Profits at the rendezvous, but…
The major indices started the week down sharply on Monday, before recouping their losses and ending with a slight gain. The eyes of traders were momentarily fixed on the coming announcement of financial results, in this week rich in announcements, for 180 of the 500 companies of the S&P 500. Currently, 78% of the companies of this index which published their results have exceeded the analyst expectations, Forbes tells us. But we are talking here about data reflecting the past, while the horizon is clouding over.
The list of recitals is always longer. The pandemic is not over yet, and it could generate other economic fluctuations, in particular with the arrival of new variants, analysts from Desjardins Group remind us. Moreover, China is once again swept away by the wave, which is now knocking on the doors of Beijing after having pushed Shanghai into full confinement. Its zero COVID policy adds to distortions in supply chains.
Among the geopolitical risks, a more widespread conflict in Ukraine that would directly involve NATO countries would have very serious humanitarian and economic consequences. “Even without reaching this point, the war in Ukraine could further deteriorate the economic situation, in particular by a new upsurge in the prices of energy, raw materials and food. […] The war could also further damage the confidence of households, businesses and investors, in addition to exacerbating supply chain problems and inflationary pressures,” adds Desjardins.
For their part, central banks are grappling with the potential for a more lasting acceleration in price growth, in the context where too sudden a tightening of monetary policies could trigger a negative reaction from the markets and amplify the economic slowdown already expected on a global scale.
The American mortgage giant Fannie Mae recently spoke of a modest recession in the United States in 2023, less intense than that of 2008. The 15-year mortgage rate, a popular term in the United States, then touched 4.4%, against 2.3% a year earlier. According to wall street journal, the risk of a recession being declared in the next 12 months now stands at 28%, down from 18% in January. Other analysts have quantified the probability between 30% and 40%, taking inspiration in particular from an inversion of the yield curve, the harbinger of a recession of which has a success rate varying from 75% to 80%. But whose precision is eroding with the action of quantitative monetary easing and restriction policies that distort the reading.
In Canada, the risk of recession remains averted due to the weight of oil, raw materials and commodities in the economy. But that of a pronounced correction in residential real estate prices remains present, while the stock market is not immune to a correction.
Place your bets…