According to some historians, ’safe-haven’ US Treasury bonds have seen their worst start to the year since 1788. While that has meant negative returns to the tune of almost -15%, some other assets have been hammered even more. Unsurprisingly, emerging market assets have, yet again, found themselves between a rock and a hard place. Hard-currency emerging market bonds have lost more than 20%, emerging European stocks more than 80%, and digital assets more than two thirds of their value.

On the positive side, anything energy- or commodity-related has done extremely well, with oil & gas stocks up more than 20% and some energy commodity indices up almost 70%. Beyond commodities, currency moves have been the most noteworthy, as the USD has appreciated in sync with commodities. In earlier cycles, commodity price jumps were preceded or accompanied by USD weakness. A reversal of this relationship shows you just how historic the first half of 2022 has been.

Some of the drivers behind the moves mentioned above have also been historic. Please do not bother to go back to the history books for 1788 – that was an emerging market crisis in itself where the US was the emerging market under fire. This time the circumstances are different: at the outset of the year, the US Federal Reserve shocked markets by admitting that it was way ‘behind the curve’. This was probably only done in response to massive public pressure and in the knowledge that an election was coming up in November. The rule of thumb I learnt about the US is that no president (or his party) has ever been re-elected with gas prices above USD 4 per gallon – they are trading just shy of USD 5.50 today.

Outside the US, the war on Ukraine has shattered confidence about the geopolitical order in Europe and has sent commodity prices skyrocketing. China has also raised fears about missing its growth targets due to its zero-Covid-19 strategy. So now at the end of June, the consensus has built up that a recession is imminent. It is interesting to see that bond markets hardly agree.

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Why do we think a recession is less likely than the general consensus?

Fed officials, including Chair Jerome Powell, are showing their determination to slow the economy to achieve lower inflation rates. History suggests that Fed policy tightening more often than not results in a recession.

At the same time, it matters a lot how aggressively the monetary policy stimulus is being reduced. In the past 60 years, US policy tightening in the range of 300-350 basis points has usually been digested quite well by the economy, avoiding a recession. This was the case when the Fed tightened from 1993-95 and 1983-84, as well as during the long tightening cycle in the 1960s (1961-66). The latest tightening episode from 2015-19 was also not particularly aggressive.

However, the pandemic has made it impossible to assess if a recession could have been avoided. We expect the Fed to tighten policy by 325 basis points in two years (2022-23), which should be digestible by the US economy and avoid a recession.

Financial markets do not fully share our optimism that a recession can be avoided. The analysts’ consensus sees the probability of a US recession in the coming 12 months at around 35%, which is higher than our expectation of 20%. Probability estimations based on the slope of the yield curve vary between 7.5% to 22%. Enhancing recession predictions by the dynamics of corporate earnings or corporate credit spreads so far results in even lower probabilities of a recession, and the latest survey of professional forecasters shows that the recession probability has declined from over 28% in Q1 2022 to around 25% in Q2 2022.

Based on the variety of calculated probabilities of a recession and our outlook for a policy tightening by the Fed, we attach a 15%-25% probability of a US recession in the coming 12 months.