The odds of a hard landing in the US remain a concern. While risk assets may have stabilised, albeit temporarily, following the Silicon Valley Bank and Credit Suisse episodes in March, as well as First Republic Bank this week, we continue to see weakness in a range of markets and macro-economic signals. Moreover, the magnitude and speed of the interest rate tightening cycle last year is only now starting to impact both the Australian and global economies and asset markets.

A key challenge is that we cannot disprove that a soft-landing scenario is not possible. However, many financial experts suggest the contrary based on key macroeconomic signals such as:

1) yield curves have never been this inverted and not signalled a recession;

2) bank lending standards have never been this tight without signalling a recession; and

3) the economic leading indicators have never been this negative without signalling a recession.

On a positive note, the CPI figure released 26th April in Australia, together with US Treasury yields, have declined following the moderation in inflationary pressures. This has been supportive for interest rate sensitive growth companies. However, whilst markets may be pricing in interest rate cuts towards the end of the year / early next year, we remain cautious about the possibility that rates locally and abroad may stay flat or higher for longer, given the 11th rate hike in the past 12 months.

Furthermore, renewed weakness in equities over the past few weeks has been principally driven by a “continuation” of the down trend in US regional banks as referenced above. More broadly, equity market breadth has been extremely narrow with a handful of super-sized technology companies remaining resilient and masking the underlying weakness in equity markets.

The second factor has been the focus on the US debt-ceiling. While we see that “event” as probably something to fade, a legitimate related concern might be the potential implication it has for tighter fiscal policy.

The final point to note is that the New York Federal Reserve’s recession model indicates that the probability of a US recession is around 60%. The model incorporates the yield curve which is at levels that has always led to a recession. Note that the probability is higher than it was heading into the 2008 GFC crisis. Moreover, it is consistent with the tightening in lending standards, manufacturing surveys, small business, homebuilder, and consumer confidence. Our sense is that lending conditions will only tighten further from here. Small US banks face tougher regulation, falling net interest margins and the decline in bank lending has already been at a recessionary pace.

Overall, this suggests that the equity markets remain too optimistic on the outlook for growth and profits, requiring us to maintain our cautionary posture.

Equity markets remain too optimistic