Markets labor under recession cloud

The Federal Reserve may be nearing its target for a tight US labor market, but recent economic indicators have markets questioning whether this progress comes at the cost of a looming recession. Futures markets initially favored a Fed interest rate hike to 5.0-5.25% next month but have since become divided on whether further tightening will occur, instead predicting over 60 basis points of easing by year’s end. Even with real consumer price inflation still at 6%, some Fed officials still think it is too early to declare victory. Cleveland Fed chief Loretta Mester, who is not a voting policymaker this year, claims that the Fed may need to move “somewhat further into restrictive territory this year, with fed funds rate moving above 5% and the real fed funds rate staying in positive territory for some time.”

Despite this assertion, the two-year Treasury yield dropped over 20 basis points during the day to hover above 3.8% on Wednesday. The dollar has fallen to its lowest level in more than two months, stoking concerns of a potential recession.

The market’s recession concerns are even more apparent in light of the March banking stress, which caused stocks to stumble. The S&P500 pulled back half of a percent on Tuesday and futures likewise remain in the red. Though a rotation of investments into so-called “quality” mega-cap stocks somewhat buoyed the industry average, overall valuations suggest that equities may still be too expensive to account for a recession. Even projections for 2023’s full-year S&P500 earnings growth rate turned negative for the first time this week.

The picture remains unclear elsewhere in the world, as manufacturing surveys earlier in the week showed factories being troubled while service sector surveys on Wednesday showed improvement, albeit inconsistently across countries. In Germany, February saw industrial orders rise but engineering orders decrease. Finally, in a sign that other central banks share the Fed’s concerns about potential economic headwinds, the Reserve Bank of New Zealand unexpectedly raised its policy interest rate to a 14-year high of 5.25%, up 50 basis points from prior levels.

Also making headlines is Taiwan President Tsai Ing-wen’s upcoming meeting with US House Speaker Kevin McCarthy in the US. This will be the first meeting between a Taiwanese head of state and a House Speaker on US soil, but China, who claims sovereignty over Taiwan, has threatened retaliation in response.

Other key events to look out for on Wednesday include the release of the US ADP March private sector jobs report and the US and global March service sector surveys, the release of chapters of the IMF’s Global Financial Stability report, speeches from European Commission President Ursula von der Leyen and European Central Bank chief economist Philip Lane, and announcements from the US House Speaker’s meeting with President Tsai and Brazilian bike-sharing company Tembici’s new partnership with Uber Technologies Inc.

By Mike Dolan, Editing by Bernadette Baum; [email protected]. Twitter: @reutersMikeD