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Bitesized bonds: can the Fed engineer a soft landing?
May 3, 2022
As central banks look to control inflation, the question many of us are asking is: does a recession lurk just around the corner, or will the Fed manage to engineer some sort of a soft landing?
The Henley Fixed Interest Team has been doing some macro research – and they think the answer lies in the 1950s, 60s, 70s and 80s.
In the years between rock and roll, Beatlemania and MJ, they’ve spotted a recessionary indicator. And it’s visible in the relationship between CPI and the rate of unemployment.
Want to know more? Lewis Aubrey-Johnson gives us a round-up of the decades. And all in under three minutes.
So a key topic on many of our minds at the moment is, with all of this inflation around, what chance does the Fed have of being able to raise rates and extinguish this high inflation without leading to a recession. In other words, can the Fed engineer some sort of soft landing?
There’s been a lot of research written on this topic in recent weeks, but actually our own economist has found a rather nice recessionary (US recessionary) indicator in which he compares the rate of unemployment in the US with inflation (CPI) – and he reckons that whenever the CPI is higher than the rate of unemployment, you typically get a recession within two years.
So let’s just look at the times going back fifty or sixty years where that has been the case – when inflation has been higher than the unemployment rate.
First of all, in December ’50, inflation was higher, and we had a recession not within two years, but within three years.
The next occasion in April ’57 – there was a recession just a few months later.
In 1966, CPI very briefly went above the rate of unemployment – there was no recession. So that’s an exception.
Then in June ’68, the lines crossed again. There was a recession the following year.
The lines crossed again in April ’73, and there was a recession later on that same year in October.
In January ’78, the lines crossed again and there was a recession by the end of the following year – in ’79.
And finally, the CPI went above the unemployment rate again in May ’89, and there was a recession by the following summer.
Just as a reminder, the current rate of unemployment is 3.6% and the current CPI level in the US is 8.5%, so on that indicator, it looks like a recession is pretty likely.
What does that mean for us as bond investors? Well, for the time being, it’s pretty rough going. Yields are rising everywhere – it’s difficult market conditions. But, at some point, we’re going to get potentially a very good investment opportunity, and we’ll just have to see about the timing of that.
More about the series
This video forms part of our fixed income series, Bitesized bonds. Each month brings a new, easily digestible instalment. Catch up on all things fixed income in under three minutes.
This month, you heard from Lewis Aubrey-Johnson, Head of Fixed Income Products. Want to know more about Lewis and the team? Click the link below.
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Data is provided as of 27 April 2022, sourced from Invesco, unless otherwise stated.
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