April 26, 2023 | By Hank Cunningham
Global growth prospects have deteriorated, with the IMF downgrading its outlook. In light of recent developments in the banking industry, the global economy will be fragile. Recession forecasts are growing, and some are concerned about an impending credit contraction.
Inflation may have peaked in the developed world, but it is moving only grudgingly lower and will likely not reach central bank targets anytime soon. Central banks have not finished their tightening cycles and further hikes in official rates are in the cards, as presaged by several Federal Reserve spokespeople.
Without doubt, there have been increasing signs of slowing economic activity, particularly in retail sales, manufacturing and the heretofore robust employment market.
Will there be a recession? More time is required to gauge how the monetary tightening over the past year has impacted the economy. As well, there are concerns that a credit crunch could occur as lending standards tighten. Pockets of economic strength remain, and most forecasts are for modest positive GDP growth.
Central banks will likely retain their restrictive stances for the balance of the year; inflation will remain the overriding concern and with some recent setbacks in core inflation, both in North America and overseas, it is possible that bond yields could move back up. However, it is more likely that the 10-year yield will gravitate to the 3.25% level, given the growing weakness in the economy. Also, it is premature to forecast any reversal in central bank monetary policy.
Consumer confidence has been dealt a huge blow, which may contribute to a meaningful near-term contraction in economic activity. Already, retail sales have markedly declined. Fed tightening over the past 14 months is working its way through the system and the recent liquidity calamity is evidence that tightening is straining the U.S. economy. Once this passes, and it will, market participants will re-focus on inflation, the economy and the Federal Reserve.
Inflation remains the number one issue facing fixed income markets and investors. After slowing over the previous four months, inflation in the U.S. is picking up again, particularly in the important services sector where wage growth is accelerating. It is premature to measure the impact of monetary tightening to date as it takes time to work its way through economies. With recent data exceeding estimates and inflation still high, central banks will most likely continue to tighten.
The yield curve will stay inverted for a while, but it has normalized meaningfully of late. In the meantime, fixed income investors can earn 2% to 5% plus on short-duration bonds, thus producing positive returns with minimal risk to principal.
In summary, there will be more drama and wild fluctuations in bond yields, and we still expect a wide trading range of 3.25% to 4.25% on the U.S. 10-year Treasury bond. It approached 3.25% but has bounced back up to 3.42%.