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Principal AM echoes delayed recession outlook

Yasmine Masi18 October 2023
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Principal Asset Management has joined other managers in forecasting an eventual recession with further economic slowing, as market conditions present opportunities for fixed income (FI) investors.

The fund manager’s fourth-quarter fixed income outlook believes policymakers will continue on their hawkish trajectory and counter expectations of rate cuts in 2023 and implement a budget for easing rates in 2024.

“Robust consumer spending continues to support U.S. economic growth, causing many market participants to re-evaluate their recession expectations and embrace the elusive soft-landing scenario as the consensus base case,” the report said.

“However, it is presumptive to extrapolate recent strength in consumer spending for many reasons including (but not limited to) the lagged impact of Federal Reserve (Fed) and commercial bank tightening, normalizing corporate profit margins, a more balanced labor market, dwindling excess savings, increasing consumer delinquencies and credit card debt, and student loan payments resuming.

“While we agree that a recession does not appear imminent, we strongly believe that further economic slowdown remains on the horizon, ultimately culminating in a recession. The yield curve—which is arguably the most reliable indicator of a recession—has inverted nine times since 1968, of which a recession has followed eight times. Soft landings have only occurred after Fed hiking cycles that were not accompanied by a yield curve inversion.

“A close examination of current economic metrics relative to the prior eight inversions does not suggest that this time will be different. Recent economic data is consistent with the evolution in prior inversions/recessions including purchasing managers indices, jobless and continuing claims, nonfarm payrolls, and bank lending.”

With consumer spending showing no signs of slowing, the report said the timing of a recession has become unclear. This has allowed fixed income to offer attractive opportunities for investors as the Fed “maintains their higher-for-longer rate stance”.

“[This is] most notably in short-dated instruments that have less sensitivity to credit spreads (spread duration). With most market participants now expecting a soft landing, spreads in credit sectors are tight relative to history. Although some additional tightening is possible, spreads are likely to start to drift wider when a recession does begin to materialize,” the report said.

“While market participants will continue to view positive economic data as further evidence of an impending soft landing, many recessionary signals are still flashing red as we head into the fourth quarter of 2023, including one of the most reliable recessionary indicators – an inverted yield curve. And while it may not be on the immediate horizon thanks to surprisingly robust consumer spending, we expect further economic slowing that ultimately culminates in a short and shallow U.S. recession over the near term.

“Most fixed income asset classes should fare well, supported by attractive yields and resilient fundamentals. While no one can say for certain what the final quarter of 2023 will hold, we are preparing for heightened economic uncertainty and turbulence.”

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