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Last week, the S&P500 continued to follow the pattern seen in 2008, see chart below.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Quantifying the Role of Interest Rates, the Dollar and Covid in Oil Prices
https://www.bis.org/publ/work1040.pdf
Labor Force Exiters around Recessions: Who Are They?
https://s3.amazonaws.com/real.stlouisfed.org/wp/2022/2022-027.pdf
Dollar Reserves and U.S. Yields: Identifying the Price Impact of Official Flows
See important disclaimers at the bottom of the page.
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In March 2021, the FOMC thought the Fed funds rate would be zero at the end of 2023. Now they think the Fed funds rate at the end of next year will be 4.5%, see chart below.
Our attached Slowdown Watch PDF shows that the US economy is still overheating, with unemployment at 3.7% and inflation at 8.3%.
Source: FRB, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The consensus is now expecting a recession in Germany in 2023, see chart below.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Although services make up 80% of GDP, fluctuations in the goods sector are still important. Inventory levels are normalizing as a result of the supply chain improving and the goods sector of the economy slowing down, see chart below. Inventories for wholesalers are back to pre-pandemic levels, but inventories for retailers are still substantially below 2019 levels.
Source: Census Bureau, Haver, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Survey-based and market-based measures of inflation expectations are starting to decline, and the market believes that the Fed will get inflation down to the FOMC’s 2% target, see charts below.
Source: FRBNY, Haver, Apollo Chief Economist Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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With rates rising and the dollar going up, foreign private investors are buying US Treasuries at a record pace, see chart below.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The consensus now sees a 50% probability of a recession in the US and 60% chance of a recession in Europe and the UK, see chart below. Investors should be positioned accordingly.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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US and European inflation for the past two years has been almost identical despite the fiscal response to covid being double the size in the US relative to Europe, see charts below.
With a much more aggressive fiscal response in the US, both headline and core inflation should have been much higher in the US today than in Europe.
The identical path of inflation in the US and Europe strongly suggests that inflation is not driven by demand but instead by supply problems associated with covid. Some of these supply problems for goods will get resolved quickly as supply chain problems ease. But other supply problems in the labor market will take some longer time.
The implication for markets is that the Fed and the ECB may not need to do much demand destruction to get inflation down.
This topic is also debated in several Fed working papers at the moment, see here and here.
Source: Bloomberg, Apollo Chief Economist Source: OMB, ECB, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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There is a striking similarity between how the S&P500 has traded during this period of high inflation and the pattern we saw during the financial crisis in 2007-2008, see chart below. Maybe one conclusion is that when investors are faced with extreme levels of uncertainty, the behavioral response in financial markets over time is relatively similar. Markets think the problems are over and want to go higher but as more data comes in, then realize that the shock is still here and the downside risks are still substantial. Our latest Slowdown Watch is available here.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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