The risk of US recession in 2023 surges

Kieran Davies

Coolabah Capital

The risk of a recession in the US in 2023 based on bond/equity market pricing and forecasts has surged as interest rates have risen and equities have slumped, with investors factoring in the risk of a Fed-driven recession to bring inflation under control. 

Coolabah Capital Investments' US recession risk forecasting models, based on bond and equity markets, now signal a material risk of recession, most likely in 2023 based on recent price action and market pricing and US economist estimates of future price movements. They had previously pointed to a heightened risk of recession.

This indicates that the market is starting to brace for the Fed to engineer a recession to rein in high inflation, something that is common in past tightening cycles.

  • The bond market – which provides the most reliable economic signal – now signals a much higher risk of recession in late 2023/early 2024 of over 50% based on a mix of market pricing for the short end of the yield curve and economist forecasts for the long end or about 25% based on economist forecasts of interest rates.
  • The stock market – which tends to give more false signals – also now points to a much higher risk of recession of about 40%, albeit in the first half of 2023, assuming that stock prices do not recover from current levels over the rest of this year.  

In this context, it is interesting that one of the macro models used by the New York Fed is now predicting a slight contraction in US output in 2023.  The model is a DSGE model, which is a variety of model that central banks sometimes use for scenario analyses given their forecasting performance is poor. With this qualification in mind, it is noteworthy that it is forecasting any risk of contraction as it is rare for a macro model to show a decline in output ahead of time.

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Kieran Davies
Chief Macro Strategist
Coolabah Capital

Based in Sydney, Kieran Davies joined Coolabah Capital in 2020, an asset manager than runs over $7 billion in fixed-income strategies, and is responsible for macroeconomic research and investment strategy, contributing to the investment decisions...

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