Hawkish Central Bank Surprises Reinforce Recession Fears

June 27, 2023

The globe watched as Wagner troops left Ukraine this past weekend to confront Russian Military leadership. Much of the world assumed a coup was underway. However, an agreement was made as the troops approached Moskow, and Putin remained in power. If you are like me, you were glued to this story through the weekend, hoping for an end to the war and Putin’s regime.

From a market standpoint, Russia and Ukraine only matter so much as they influence commodity prices, and the political upheaval over the weekend has not moved oil or grain prices notably. Looking forward, obviously, this injects more geo-political uncertainty into the world, but as long as commodity prices don’t spike higher, the markets will largely ignore Russian political volatility.

The more critical market news occurred on Thursday and Friday of this past week. On Thursday, the Bank of England and Norges Bank (Norway’s Central Bank) surprised markets with 50-bps rate hikes. These hikes echoed the message and action from Australia’s central bank a few weeks ago and Chairman Powell last week. We are not out of the woods yet.

Thursday was a notable tipping point for general market expectations as a focus on inflation, and soft-landing hopes gave way to recession fears. Stock futures were lower on Friday as Purchasing Managers Index (PMI) Flash data out of Europe badly disappointed as the growth gauge indicated the European economy slowed to a near standstill in June. In the US, the Composite PMI was solid primarily due to resilience in the services sector, but that strength further supported a higher-for-longer rate outlook.

he Market Is Beginning to Believe the Fed

As we have been writing and talking about throughout the first half of the year, there seems to be a disconnect between what the market is doing and what central banks are saying. Over the past two weeks, the hawkish (restrictive monetary policy) central bank commentary and actions hiking rates have increased market fears that high rates will ultimately cause a real, meaningful slowdown in economic growth. The data and actions from the past two weeks run counter to the market’s “Immaculate Disinflation” hope that pushed stocks higher in early to mid-June. “Immaculate Disinflation” assumes falling inflation and stable growth, not falling inflation and slowing growth.

After June’s Fed decision, investors widely anticipated that the “pause” or “skip” decision would mark the end of the rate hiking cycle. Investors saw inflation dropping and resilient growth. However, the dynamic began to change almost immediately with the European Central Bank’s hawkish comments that all but guaranteed more rate hikes in Europe. Then last week, UK CPI came in hot, and the Bank of England raised rates by more than expected, while Powell maintained a hawkish tone and said that a unified Fed continues to anticipate more rate hikes between now and year-end as they continue to fight inflation.

The bottom line is momentum in stocks remains higher, and last week’s pullback needs to be viewed primarily as digestion/consolidation of the intense April – June rally. But the single biggest threat to this rally is an economic slowdown. So while the recent data and central bank comments aren’t conclusive, we continue to monitor the data because if it points toward a slowing economy, then that does have the potential to erase the suddenly widespread optimism toward stocks and cause a meaningful pullback.