Milan Cacic
November 10, 2023
CLARITY IN CHAOS
A recession seemed inevitable after 2022’s equity bear market and the March bank failures, yet the economy held. Now we are being bombarded with even more conflicting data: automakers are slashing prices of electric vehicles, oil is selling off, bond yields are dropping, Fed Reserve communication is becoming more dovish, yet the November jobs data showed 150,000 new jobs.
In conversation with clients over the past few weeks, I am hearing that people are not desperate for employees anymore. Companies are becoming fully staffed and the help wanted signs are being put away. Between all the conflicting data and the TWO global conflicts happening, it can become difficult to figure out which direction this economy is going.
One set of data which might provide some clarity within all this chaos is credit spreads. Credit spreads have consistently predicated not only recessions but also recession depth. The credit spread is the additional amount above government rates that companies must pay to borrow money. For instance, if a 5-year government bond pays 5% and company XYZ is paying 8% to its lenders, the credit spread is 3%. A wider spread (companies paying higher premiums) is a sign that the economy is either not good or going to get worse. Higher premiums are a result of lenders wanting more return for the perceived risk of an upcoming recession because companies do not do as well during a recession.
As you can see from the chart below, the market was predicting a recession earlier on in 2023 however it never transpired. Again, starting in October, the credit spreads widened indicating a potential recession. However, over the last two weeks, the spreads have dropped significantly, indicating no recession in the short term. Maybe what the market is trying to tell us is that there will be no recession, or, even if there is one, it will not be as deep as some think. If interest rates continue to decline and the credit spread does not go up, it is likely either the recession will be mild, or we will get away with a soft landing. Time will tell!
Source : https://fred.stlouisfed.org/series/BAMLH0A0HYM2 as of Nov-09-2023
I've also included a piece from our CIBC Economics team entitled "Waging war on US wage inflation: Can the Fed cool the fires? ".
As always, if you have any questions, please feel free to give us a call at any time.
Have a great weekend.
Milan