US recession risks rapidly rising

Anthony Doyle

Firetrail Investments

Financial conditions are central to the US outlook. Fed Chair Jerome Powell stated earlier this year that "Policy works through financial conditions. That's how it reaches the real economy".

In contrast to Australia, the US economy doesn't respond directly to increases in short-term interest rates. Most home owners aren't affected, as they have long-term, fixed-rate mortgages. Some of these mortgages may not reset for decades to come.

Of greater importance to the confidence of American households is the portion of their wealth invested in the equity market. They are sensitive to financial conditions, with a falling equity market often resulting in declining consumer confidence and spending. 

Higher interest rates, rising credit spreads, and a falling and volatile equity market have all contributed to the rapid tightening in US financial conditions this year. This suggests downside risk for the US ISM, a key monthly indicator of US economic activity. 

An ISM level above 50 indicates an expansion of the manufacturing segment of the economy compared to the previous month. A reading of 50 means no change. A reading below 50 suggests a contraction. US financial conditions, which have shown a good relationship with the ISM through the business cycle, now indicate a deterioration in US activity in the months ahead.

US ISM versus Goldman Sachs Financial Conditions Index

The Fed has an inflation problem. Higher bond yields and lower share prices are now beginning to have the desired slowdown effect on the US economy.

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This communication was prepared by Firetrail Investments Pty Limited (ABN 98 622 377 913, AFSL 516821) (Firetrail). It is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. It is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. Any persons relying on this information should obtain professional advice before doing so.

Anthony Doyle
Head of Investment Strategy - Firetrail S3 Global Opportunities Fund
Firetrail Investments

Anthony Doyle is Head of Investment Strategy for the Firetrail S3 Global Opportunities Fund. His primary responsibilities include fundamental idea generation, portfolio analysis, and economic insights including currency and macroeconomic risk...

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