Recessionary fears

Posted By Darren Winters on Jun 10, 2019


Recessionary fears

Recessionary fears are looming again at a time when nearly every single asset class, except for equities, is now pricing in something of a sharp global slowdown.

Investors are energizing the risk off trade with recessionary fears weighting capital flows towards safe haven assets.

The rates market is now pricing in almost 4 rate cuts by the end of 2020 and long positions in Eurodollar rates futures are currently at levels last seen around the European financial crisis.

Recessionary fears have got investors on alert for a deflationary tsunami to sweep across the world

The fact that stocks are near an all-time high is a bad omen for stock fundamentals, but it also means that the Fed and more QE could be just around the corner. It is warp logic where bad news is goods news for stocks.

Put simply recessionary fears means that stocks could rally into a recession as the central bank keeps adding assets to their balance sheet. So don’t look to equities to give you a heads up for the next financial crisis.

Recessionary fears and risk off mood can be seen by analyzing capital flows into less risky assets classes

Take for example, less riskier categories like HY (-$2.9bn), bank loans (-$1.4bn) and EM (-$0.7bn), bonds in fact saw even larger inflows ($22.7bn) this week, the largest on record with government bond funds (+$8.9bn) seeing the bulk according to DB’s Parag Thatte.

With recessionary fears looming investors are piling into bonds with good credit ratings.

Money market funds are also experiencing positive capital flows triggered by recessionary fears

Recessionary fears

Money market funds (+$31.3bn) have seen tremendous inflows, taking the total over the last six weeks to an incredible $138bn, the largest on record over comparable periods in previous years as investors also flee to the safety of cash.

As you can see from the chart, Money market funds have seen almost $140 bn flow in over the last 6 weeks, which dwarfs those in corresponding periods in previous years.

Deutsche Bank sums up the Risk-off trade sentiment as recessionary fears gather momentum.

“Risk-off trade intensifies with bond getting multi-year high inflows; money market funds benefit notwithstanding seasonality,” writes Deutsche Bank.

Gold funds (+$1.5bn) last week also saw the largest inflow in over 2 years. Gold long futures positioning also rose sharply to the highest in a year.

Flow of capital into gold chart.

But stocks continue to buck the risk off trade. Equity futures positioning rose this week and remains elevated after declining, albeit modestly for 4 straight weeks, according to DB. positioning in equity futures rose this week and remains near the top of its historical range. There is a disconnect between equities and virtually every asset class.

Recessionary fears have got investors convinced about another central bank rescue attempt.

Even though some investors are growing weary that QE could also be subject to the laws of diminishing returns.

But the US economy could be sliding into a recession by the end of 2020, according to America’s business leaders. Moreover, the recent disastrous jobs report is the latest to support the recessionary fears are looming view.

So investors are betting that the Fed will do everything in its power to keep assets prices propped up. In other words, investors are betting that the Fed will cut rates, do another round of QE, perhaps NIRP – to keep the markets jolly.

But will it work this time around?

Recessionary fears looming in the EU with the ECB president Mario Draghi recently saying that the ECB is prepared to unleash the latest “trial balloon”

Put another way, ECB policymakers “are open to cutting the ECB’s policy rate again”.

It is in the UK where recessionary fears are looming the most

The view amongst economists that the UK is falling into recession is rising. the Office for National Statistics reported the economy shrank 0.4% in April compared to March.

A dramatic fall in car production and rising political turmoil are being blamed for a waning UK economy.

Alessandro Capuano at Fineco Bank said: “Political uncertainty is finally taking a toll on the UK economy. After a resilient start to the year fuelled by Brexit stockpiling efforts, maintaining that momentum is proving a challenge”.

That 0.4% fall was far worse than the 0.1% decline forecast by the City. So the pound continued to march to the end of the dollar exchange cliff at$1.27, down from $1.40 a year ago.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: “Q2 GDP now looks set to be awful — we’re revising down our forecast for quarter-on-quarter growth to zero from 0.2%.”

With recessionary fears looming in the UK that suggests the Bank of England could be forced to cutting interest rates

Markets are pricing in a 30% chance of the Monetary Policy Committee cutting base rates before the end of this year. James Smith at ING said: “Most of this should only prove temporary, although rising uncertainty surrounding Brexit and the growing likelihood of an autumn general election means the Bank of England is unlikely to raise rates in 2019”.

With recessionary fears looming investors are betting on lower central bank rates for longer, perhaps even forever.

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