If there’s one dominant theme in our inboxes right now – aside from the usual murmur of ESG and crypto bullshit – it’s that everyone seems to be terrified of the possibility of an impending recession.

The inverted U.S. yield curve is clearly a big factor.Those who want to better understand the pros and cons of yield curve divination should take a look This 2019 FT article. Little has changed in these arguments since then. (If you have a different view of the yield curve, our data scientist colleague Alan Smith set to music here.)

But no matter what the yield curve is doing, there is clearly growing concern that uncomfortably high inflation will push central banks, led by the Federal Reserve, to raise interest rates faster than expected a few months ago.hell, even Lyle Brainard Now her hiking face.

Deutsche Bank last week became the first major bank to predict a recession, with its top economists David Volkertz-Landau and Peter Hooper arguing:

Two shocks in recent months, the war in Ukraine, and the build-up of inflationary momentum in the U.S. and Europe have led to sharp downward revisions to our global growth forecasts. We now expect a recession in the US and a growth recession in the euro area within the next two years.

The war has turned into a stalemate unlikely to be resolved anytime soon, disrupting activity on multiple fronts. These include turmoil in markets for energy, food and critical materials, which in turn further disrupts global supply chains. We assume that the critical gas flow from Russia to Europe will not be cut off, thus avoiding the cost of the crisis deepening the European and global economy significantly, but this remains a downside risk.

Inflation in the U.S. and Europe is currently pushing 8%, well above expectations in the most recent December. More disturbingly, especially in the US, there are signs that the underlying drivers of inflation have widened, stemming from very tight labor market conditions and spilling over from goods to services. Inflationary psychology has shifted markedly, and while longer-term inflation expectations have not yet shaken off their anchors, they are increasingly at risk.

The Fed, which finds itself far behind the curve now, has sent a clear signal that it is moving into a more aggressive mode of tightening. We now expect the federal funds rate to peak at over 3-1/2% next summer, with balance sheet shrinking adding at least a 75 basis point-equivalent rate hike. With EA inflation likely to remain at 2% or higher, we expect the ECB to hike rates by 250bps between September this year and December next year.

This tightening is expected to generate two quarters of negative growth in the US in the fall and winter of 2023-24 and reduce EA growth that winter to just above zero. After that, growth is expected to recover as inflation subsides and the Fed cancels some rate hikes. We acknowledge that there is substantial uncertainty in these forecasts, but note that downside risks and further downside risks are considerable.

At first, FT Alphaville snickered at the two-year forecast range, but the floodgates have opened. Fears of a recession are clearly on the rise. The usual caveats etc, but look at how the Google search for “recession” has skyrocketed across the globe.

Aside from the actual recession and financial crisis in March 2020, this is the biggest gain since the last inversion of the yield curve in 2019 and the Eurozone shenanigans in 2011:

In addition to the factors listed by Deutsche Bank, the Barclays economists also highlighted that given that 30 of China’s 31 provinces are now affected, and Shanghai (which alone accounts for nearly 4%), China’s Covid-19 outbreak ” can no longer be ignored” as a percentage of China’s economic output – which has been in full lockdown since March 28. Here’s Barclays:

Downside risks to global growth are rising as lockdowns in China expand, Europe begins to sanction Russian energy and the Federal Reserve signals more aggressive policy tightening. Meanwhile, high inflation could put pressure on the ECB next week to signal its willingness to act, while French elections pose political risks.

Ed Yardeni, a veteran Wall Street analyst, is largely optimistic and now sees a 50% chance of a recession in Europe in 2022 and 30% in the United States.

Yardeni sees inflation starting to moderate in the second half of the year, but highlights how every voting and non-voting member of the Fed’s rate-setting committee has recently become hawkish. That sparked expectations for a series of larger-than-usual 50-basis-point rate hikes that could lead to a recession. Here’s Big Ed:

The Ukraine war increases the likelihood of prolonged inflation, prolonged monetary tightening, and recession in the US and Europe, which we forecast at 30% and 50%, respectively. . . Indicators show that the global economy is stagnant. . . Will controlling inflation require a nudge from the Fed, or a full-blown push to trigger a recession?

AV’s intuition is that as long as the labor market remains strong and consumption is active, a recession is unlikely. With inflation still likely to moderate later in the year, that could mean a return to tradition for some Fed figures who have turned from dovish to hawkish. Other major central banks such as the European Central Bank, the Bank of Japan and the People’s Bank of China are unlikely to take drastic measures anyway, given the challenges they face.

However, none have the same influence over the financial system as the Fed. If the U.S. central bank does begin a string of 50 basis points of rate hikes, we will soon find out how resistant the global economy is to rate hikes.