“The stock market is a forward-looking mechanism that discounts future probabilities in the present,” says José Torres, Senior Economist at Interactive Brokers. And presently, this is what the stock market might be doing – bringing down the valuation of highly prized stocks.
Stock market meltdown is happening also because of a fear of recession in the US. With US inflation largely untamed at around a 40-year high level, the Fed rate hikes are solely directed towards one objective – to bring it down from over 8% to under 2%. Already, a 300 basis point rate hike has been unleashed in the economy with three consecutive hikes of 75 basis points each. In November another rate hike of 75 bps is expected while the December rate hike might come at 50 bps.
So, where does it leave the US economy? “Unfortunately, recession. Too many shocks are occurring simultaneously. Achieving a soft landing, in general, is challenging, a soft landing with inflation above 8 percent will prove even more challenging,” says Torres.
The global supply issues are not resolved fully and the Ukraine-Russia war is still on. The UK and a lot of European nations are facing financial crises too. The US is experiencing a 40-year high CPI increase where prices are rising by 8% annually. So, is a recession looming ahead? “Never have we had the CPI above 5 percent and avoided recession. The slowing consumer and weak productivity despite a tight labor market point to recession as well,” says Torres.
“Inflation is likely going to be increasingly persistent and harder to bring down than in the past. Inflation is a tough opponent that will bring recession as the Fed needs to sacrifice financial stability and economic performance in exchange for pressing the reset button and achieving price stability.
Slowing consumer spending, decades-high inflation, weak productivity, and tighter financial conditions have sparked growing concerns about a potential recession. In my view, an economic downturn is likely in 2023 due to the difficulty in achieving a soft landing in general. Achieving a soft landing with inflation above 8 percent will prove even more challenging. Fighting high inflation while simultaneously keeping economic growth positive is a challenging ordeal that could lead to a prolonged economic slowdown during which corporate earnings would be muted,” adds Torres.
Interestingly, the inversions across the 2-year and 10-year Treasuries are also pointing toward a recession. “The US yield curve is severely inverted across maturities. If history is a guide, the current yield curve suggests that the US economy can’t withstand the current level of financial tightening, with inversions across the 2-year and 10-year Treasuries preceding the last six out of six recessions” adds Torres.