Deutsche Bank Becomes First Major Bank To Predict Recession

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(Wednesday Market Open) Equity index futures are pointing to a lower open as investor nervousness increases on comments made by Federal Reserve Governor Lael Brainard. While the Fed’s hawkishness is causing concern, several developments overseas pushed the S&P 500 index futures lower and led Deutsche Bank to predict a recession in 2023.

Potential Market Movers

Starting in China, another increase COVID-19 cases took the country to a new record, and now the Chinese government is extending lockdowns in Shanghai. According to The Wall Street Journal, more than 80% of daily cases were in Shanghai, and the government is requiring millions of people to stay in their homes. As we’ve learned over the last two years, lockdowns result in lost production, clogged supply chains, and supply shortages.

The Hong Kong’s Hang Seng and the SZSE Component Index fell 1.87% and 0.45% respectively. However, the SSE Composite was about even on the day. Alibaba BABA and JD.com JD led the slide on the Asian exchanges, trading lower at 2.14% and 2.82% in pre-market action in the United States.

European markets were also trading lower after a couple of bad economic announcements and comments from European Central Bank (ECB) members. The European Union reported a 1.1% increase in its Producer Price Index (PPI) in February and a staggering 31.4% increase year-over-year. The biggest driver of the increase in the PPI was energy costs, which rose a stunning 87.2%, thanks in large part to the war in Ukraine.

The rising costs are obviously being felt by consumers and businesses, resulting in a slowdown in construction. The United Kingdom reported a higher-than-expected increase in its Construction PMI, reflecting the higher cost of inputs in that country.   

ECB members were active on Wednesday talking to the press and giving speeches. The Italian representative Fabio Panetta said the ECB wouldn’t hesitate to tighten its policy to curb inflation. However, the ECB is behind the curve as the Bank of England (BoE) has already been raising its key rate. Luis De Guindos, the Vice-President of the ECB, went a different direction saying that the key to the inflation problem would be to speed up and increase green energy initiatives.  

Europe isn’t getting any help from the war in Ukraine, as it appears Russian President Vladimir Putin isn’t ready to stop. Russia continues to attack Ukraine’s steel and grain facilities, adding to the current commodity problems. European Union (EU) leaders are now considering a ban on Russian coal which could add to the EU’s energy problems.

With all of these developments, Deutsche Bank DB analysts are now forecasting a recession in the United States and Europe in 2023. DB is the first major bank to forecast a recession, even though talk about a recession as increased in recent weeks. The analysts are also concerned that inflation will become unanchored and out of control.

As one might expect, European markets were trading lower on the slew of bad news. The STOXX Europe 600 was down 1.56%, the German DAX fell 1.87%, France’s CAC 40 dropped 2.03%, and London’s FTSE 100 traded 0.68% lower.

Looking at inflation a little closer to home, there are a couple of important economic reports due out later today that could move the markets. After the open, crude oil inventories will provide insights into the supply side of the price of oil. In the afternoon, the FOMC Meeting Minutes will give investors a peek inside the discussions of the last Fed meeting.

Reviewing the Market Minutes

Governor Brainard was part of a virtual conference on Tuesday that allowed her to share some prepared remarks. However, her remarks took stocks from the positive to the negative. She said that inflation is of “paramount importance” and that the Fed would reduce its balance sheet at a more rapid pace than in the past. She told viewers that the Fed has an opportunity to raise rates in every meeting this year, but she also foresaw that the United States economy was strongest enough to handle the rate hikes.

Governor Brainard’s remarks caused yields to rally with the 10-year Treasury yield (TNX) rising nearly 6% and closing at 2.556%. Similarly, the 2-year Treasury yield rose from 2.45% to 2.524% on the day for a change of 3%. The moves steepened the yield curve and put the yield for the 10s higher than the 2s. Much of the Fed’s balance sheet deals in longer-term Treasuries because the Fed was using its purchasing power to provide liquidity at that end of the curve when it was stimulating the economy during the pandemic. It’s also the reason the 10s rallied more than the 2s. Ms. Brainard’s comments may have been a calculated move to signal to investors that the Fed is paying attention to the yield curve and may work to normalize it.

Whether the Fed is being mindful of the yield curve or not, higher yields mean a change in stock valuation, which is one reason the Nasdaq Composite ($COMP) and the S&P 500 (SPX) closed 2.26% and 1.26% lower on the day.

Investors also saw a weaker-than-expected ISM Non-Manufacturing PMI report, although it was higher than the previous month. While the growth wasn’t as much as forecasters had hoped, it did reflect growth in the service side the economy. A lesser-known inflationary measure that came with the report is the Prices Paid Index, which had its second-highest reading ever. This likely sparked concerns about inflation and provides another reason for the Fed to be more aggressive. 

A day after it was revealed that Tesla TSLA CEO Elon Musk took a 9.2% stake in Twitter TWTR which prompted the stock to rally 27%, a new filing released Tuesday morning revealed that Mr. Musk will join Twitter’s board of directors. The position will limit his ability to accumulate more than 14.9% of the company if he chooses to buy more shares. Currently, he’s already the largest shareholder of Twitter. TWTR rallied nearly 10% on Tuesday but sold off with the rest of the market in reaction to Ms. Brainard’s comments. However, it still closed 2% higher on the day. 

Three Things to Watch

Bad Breadth: It’s hard not to feel hopeful after seeing stocks finally rally over the last two weeks, but unfortunately, there just isn’t a lot of breadth to the rally. Breadth is a measure of how many stocks follow a benchmark like the S&P 500. A broader rally tends to reflect a greater amount of bullishness among investors. The stronger bullish sentiment often indicates how long the rally will run.

Soldiers & Generals: Another way investors look at market breadth is through the prism of soldiers and generals. Some investors look at the S&P 500 as generals because they are 500 large- and mega-cap stocks that tend to be the best or near the best in their sectors. The Russell 2000 (RUT) is often seen as the soldiers. They are small-cap stocks that have a higher risk of failure.

The theory works as such: If the soldiers are no longer following the generals, then the war is almost over. This is why breadth is a popular indicator for many investors.

House on the Sand: The ground under homebuilders appears to be eroding away every time the 10-year Treasury yield moves higher. The 10-year yield is correlated with mortgage rates, which means it just got more expensive to buy a house. According to the Mortgage Bankers Association (MBA), the average home mortgage payment had already increased about $200 in 2022. This morning, the MBA reported another week of fewer mortgage applications and that the U.S. Mortgage Market Index is more than half of what it was from its peak in 2021. So, the rise in yields prompted the S&P Homebuilders Select Industry Index to fall 2% on Tuesday and is down nearly 27% from the first of the year.

According to a recent report by the United States Census Bureau, the number of homes being built reached 772,000 in February, which is 40% higher than the long-term average of 552,000 but shy of the 2007 high of 985,000. As rates go higher, homebuilders have a higher risk of cancellation or buyers not qualifying and may find themselves holding homes that may have to be sold at a lower price despite the cost of building materials.

Notable Calendar Items

April 7: Jobless Claims, Constellation Brands STZ earnings, ConAgra CAG earnings

April 8: Wholesale inventories, WASDE

April 12: Consumer Price Index (CPI), Albertsons ACI earnings, CarMax KMX earnings

April 13: Producer Price Index (PPI), JPMorgan JPM earnings, BlackRock BLK earnings, Delta Air Lines DAL

April 14: Retail Sales, UnitedHealth UNH, Wells Fargo WFC, Morgan Stanley MS, Goldman Sachs GS, Citigroup C

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image sourced from Unsplash

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.