By Jamie McGeever

ORLANDO (Reuters) – The U.S. is facing increasing recession risk since months. A flattening yield curve, and a slumping consumer confidence are warning signs. But the alarms suddenly sound louder due to a peculiarity in the futures interest rate market.

The June 2023-2023 Eurodollar curve is now inverted. In simple terms, traders begin to anticipate Federal Reserve interest rate reductions in the second half next year. This is before the tightening cycle even began.

This inversion has been previously observed further out on the curve, to 2024. However, this was prior to war in Europe, eyewatering increases in commodity and oil prices and the radically shifting dial in global markets.

The Eurodollar curve does not represent the Fed’s policy plan. This can be affected by perceptions of credit risk or strong hedging demands from many players, such as foreign sovereigns.

Joseph Wang, an ex-trader at the Fed’s Trading Desk, points out that it is not common and deserves attention.

This is rare but there are rare things happening. Wang explained that there was a lot of uncertainty. The banks will continue to be the heart of the financial sector. There is concern over contagion, and people may not be aware of reverberations.

FCI 6-YEAR HIGH

Are the U.S. economies likely to go into recession in next year or this year? The growth projections for 2022 are now closer to 3% than the 4% forecast at the beginning of the year. However, there is still a risk due in large part to oil. U.S. gas pumps now have the highest average prices ever.

A 3% annual growth rate would not be considered contraction. Global geopolitical, financial and other developments are happening so rapidly that there is little to no visibility for the upcoming weeks or the remainder of the year.

The Global Financial Conditions Index by Goldman Sachs (NYSE 🙂 shows that global financial conditions are the best in six decades. The rapid tightening of this year has all been due to higher long rates and wider credit spreads.

There is very little direct U.S. exposure to Russia, Ukraine, and Eastern Europe. For example, the euro area will be more severely affected by the conflict in Syria and rising energy prices.

U.S. consumer optimism has fallen to a 10 year low and is just 20 basis points from falling below the 2-year yield. Inversion of yield curve and a large fall in consumer confidence have been hallmarks of every U.S. recession over the last 40 years.

BEAR MARKET

Although rising and high inflation were on everybody’s radar at start of year, nobody had a recession plan for 2022.

Guilhem Saviry from Unigestion wrote that the markets should concentrate on the growth outlook, the pace of its deceleration, and not inflation risk which has already been priced in the bond and commodity markets.

The rosy outlook for growth at the end of 2018 was one of many pillars upon which the bullish, broad-based consensus on the 2022 equity market was built.

The ‘R’ term was not mentioned in Wall Street bank’s 2022 outlooks. Although earnings growth may slow down and valuations might seem a little high, Wall Street will still grow another 10% if the economy avoids recession.

Bank of America (NYSE) research highlights investors’ market optimism and market bullishness in January. There was a historic gap between bullish equities sentiment and bearish bonds sentiment. Only 7% of the investors predicted a recession and less that a third of them expected a bear marketplace this year.

BofA discovered that global equity funds received a record $949 million last year. This is more than any other 20-year period combined.

Even if some of this flow is lost as Wall Street declines – Nasdaq has become a bearmarket this week – but most of it remains invested, there are still opportunities for large relative value shifts and reallocations into more secure assets.

We are in control of a bear-market that has been incomplete both in time and in price. Morgan Stanley On Monday, the equity strategists at (NYSE) wrote that “As such we recommend staying defensively focused by taking less risk than average.”

(The author is a columnist from Reuters.

(By Jamie McGeever with Mike Dolan’s additional contribution; Editing done by Andrea Ricci