Market Signals Still Mixed After Fed Hike

July 28, 2022

After another rate hike and fresh GDP data, there is still no consensus on whether the current economic environment can be described as a recession. 

U.S. gross domestic product declined for a second straight quarter in Q2, fueling worries that the U.S. economy is in the midst of a recession. But rather than adding clarity to the investment outlook, the latest data only makes things fuzzier.  

According to the Bureau of Economic Analysis, Q2 real GDP declined at a 0.9% annualized rate. That follows the first quarter’s 1.6% decrease in GDP, and now with two consecutive quarters of declining GDP in the books, the criteria for a recession has been met—to a degree. 

“Two consecutive quarters of declining real GDP” is just one measure of a recession. Another comes from the National Bureau of Economic Analysis, which defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”

The NBER, a private research organization, dates recessions based on a number of factors, including GDP, nonfarm payrolls, industrial production and more. 

As unemployment hovered near multidecade lows for much of the first half of 2022, it’s highly unlikely the NBER will agree that there was a recession during that period. 

No Greater Clarity About The Future 

Whether or not we entered a recession in the first half of the year, investors care more about what will happen in the future. And in that regard, things aren’t any clearer, and it depends on who you ask. 

Mark Zuckerberg, CEO of Meta Platforms Inc., a digital advertising giant valued at over $400 billion, is convinced we are in an ongoing recession.

“We seem to have entered an economic downturn that will have a broad impact on the digital advertising business,” he noted in the company’s Q2 earnings conference call. “It's always hard to predict how deep or how long these cycles will be, but I'd say that the situation seems worse than it did a quarter ago.”  

Shares of Meta tumbled 7% on the results, helping to push the Communication Services Select Sector SPDR Fund (XLC) down by 2%. Meta has a whopping 18% weighting in the ETF. 

On the other end of the spectrum, in his post-rate-hike press conference on Wednesday, Fed Chair Jerome Powell was adamant that the U.S. economy wasn’t in a recession, and that it could avoid one altogether. 

“I do not think the U.S. is currently in a recession … there are just too many areas of the economy that are performing too well. And of course, I would point to the labor market, in particular,” Powell said, while adding that the Fed is not trying to cause a recession with its interest rate hikes.

“We're not trying to have a recession and we don't think we have to,” he noted. 

Stock Investors Feeling Optimistic  

Recently, broad stock market ETFs, like the SPDR S&P 500 ETF Trust (SPY) and the Invesco QQQ Trust (QQQ) have been more sympathetic to Powell’s macro views than those of Meta’s Zuckerberg. 

Both funds hit seven-week highs on Thursday as investors reasoned that while the economy may be shaky, most of corporate America is holding up OK so far. So far this earnings season, 68% of companies in the S&P 500 have beaten analyst estimates, according to data compiled by FactSet.  

Investors also took solace in comments from Powell that suggested the pace of central bank rate hikes could soon slow, removing some pressure from the economy. 

Still, it’s hard to tell whether the stock market’s recent recovery is a reflection of investors being forward-looking or too optimistic. The outlook only gets hazier when you look at the other big financial asset class: bonds.  

Bond Market Pessimism  

It’s hard to interpret recent bond market action as signaling anything other than a coming economic downturn. 

The 10-year Treasury yield is currently around 2.68%, 20 basis points below the two-year Treasury yield and well below where the Fed has projected it will push its benchmark federal funds rate. An inverted yield curve has preceded every recession of the past 50 years. 

The recent pullback in bond yields and increase in bond prices has helped cut losses for U.S. bond ETFs, which are still on track for their worst year on record. 

The iShares Core U.S. Aggregate Bond ETF (AGG) is down by less than 8% year to date, and improvement from a loss of 12.5% in mid-June. 

By comparison, SPY is lower by 14.2% this year, better than the loss of 22.5% it had at its low. 

This price action implies that U.S. bond investors expect a recession, but U.S. stock investors are OK with that—perhaps because they believe the recession will be mild and it’s already priced into the market.  

Only time will tell whether they’re right or not.  

 

Follow Sumit Roy on Twitter @sumitroy2      

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