Co-Heads of Investments Ben Kirby and Jeff Klingelhofer discuss the chance of a recession in the U.S., continued Fed tightening and low volatility.
Observations: Recession, Rate Hikes and Low Volatility
Adam Sparkman: Welcome back and thanks for joining us for today’s Quarterly Observations in Fixed Income and Global Equities. My name is Adam Sparkman and I’m a client portfolio manager here at Thornburg Investment Management. Today, I’m joined by our co-heads of investment, Ben Kirby and Jeff Klingelhofer. Gentleman, thanks so much for joining us today. So Ben, given the resilience of the labor market, expectations or a broad-based US recession seemed to have declined a bit over the last quarter. Has your base case regarding the timing of a US recession shifted in recent months as well?
Ben Kirby: You know, it has, Adam. I think calling a recession timing is a lot like watching an apple fall from a tree. You can observe the external forces that are gonna make it happen eventually, but the exact time is a bit more difficult. That said, there are a lot of external forces that are acting on the economy today. We have higher insurance rates, we have the Fed balance sheet contracting, um, so overall, liquidity is tightening, and we think that probably eventually does call the slowdown that we’ve seen in 2023 turn into a recession probably in early 2024.
Adam Sparkman: So, Jeff, headline inflation in the US has definitely continued to recede really over the past 12 months, but the PCE, in particular, remains stubbornly above the Fed’s 2 percent target. With the central banks’ recent shift to a more reactive approach, given the high level of core inflation and the tight labor market that we have here in the US, do you expect the Fed to keep raising rates in 2023?
Jeff Klingelhofer: You know, I think we do, right? What we’ve seen is parts of overall inflation have come down. Goods inflation is broadly back under control and, and well within the, the, the Fed’s 2 percent range and comfort zone, but much like Ben was saying, right unemployment and just the broad labor picture – and it used to be incredibly, incredibly strong – and that’s pushing up the level of services inflation, and so really, the Fed has been forced to react much like we have in markets. The Fed has been forced to react to really watch labor market conditions incredibly, incredibly closely, focusing on things like the quits rate, right? Or, or the vacancies relative to the overall unemployment rate. You know, I think from the Fed perspective, we’ve talked about this a little bit in the past, it, it hasn’t just been the greatest monetary experiment in human history, it’s really been the greatest social experiment in human history. We taught our, all of ourselves that we can borrow at incredibly low rates and really, the cost of money has been free, and the Fed wants to undo that, so my expectation is yes, we’ll continue to see the Fed raise rates, so long as inflation remain, remains stubbornly above their 2 percent target. I think they’re really looking to get it back to that 3 ½, 4 range, which we’re seeing some signs that it’s falling towards that, but we’re not there yet, um, so for, for me, yes, continued rate hikes and, and certainly a longer pause than the market was expecting.
Adam Sparkman: So, Ben, volatility in financial assets has quieted in recent months, which feels pretty standard in recovering or rising markets like we’ve seen. Do you expect this kinda low volatility environment we’ve been in to continue through the second half of the year or do you think volatility will resume as this potential recession looms.
Ben Kirby: Yeah, volatility tends to be very episodic. It’ll be, it’ll be low for a long time and then when an event happens, that’s when it spikes up. So, this year, it’s been a bit of a Goldilocks scenario, if you will in particular, expectations were very low going in to the year and growth has remained positive, even as the Fed hikes have slowed and we’ve had a nice disinflationary environment. So the big question is how far will inflation go down and how much economic contraction will be needed to achieve that. So, I would guess that yes volatility probably does increase as we near the next recession but again, the timeline of that is going to be tricky.
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