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U.S. Recession Signals Are Flashing Red, But Consumers Are Spending Their Green

Bond markets are worried about recession, oil is creeping towards $100 a barrel .. but consumers keep spending, and that's what will keep the U.S. from slipping into recession.

The strongest reading for retail sales in ten months, as well as gathering evidence that companies are navigating supply-chain disruptions, could meaningfully change U.S. growth forecasts over the coming weeks and defy market indicators of a near-term recession.

Retail sales surged 3.8% from last month to a collective $650 billion, the strongest reading in nearly a year that doubled the Street consensus forecast, even in the face of the fastest inflation headwind since 1982. Factory output to start the year was also solid, rising 0.2%, while the broader reading of industrial production was up 1.4%.

The U.S. economy, however, is powered by consumer growth, and the fact that January's numbers rebounded with such ferocity likely means first quarter growth -- which the Atlanta Federal Reserve's GDPNow tracker pegs at only 0.7% -- is likely to march higher over the coming months.

"The strength of this rebound adds credence to the idea that December sales were weak largely because people pulled holiday purchases forward, fearing shortages of popular items," said Ian Shepherdson of Pantheon Macroeconomics. "The immediate consequence of these numbers is that forecasts for first quarter GDP growth will be revised up meaningfully."  

"The range of uncertainty is still massive at this point in the quarter, but our initial fears of very slow growth in the face of the Omicron wave are now much diminished," he added. 

Both readings also seem to defying the flashing inflation signals from financial markets, and particularly in bonds, where the yield gap between 2-year and 10-year notes -- a reliable recession indicator -- is trading at just 48 basis points, the lowest levels since the pandemic trough of April 2020.

The peculiar arithmetic of fixed-income investments basically makes short-dated bonds more sensitive to interest-rate changes. 

So when short-term rates spike, traders are anticipating higher rates from the Federal Reserve; as evidenced by bets of a 50 basis point hike next month in the CME Group's FedWatch tool

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But when, at the same time, they're also worried about longer-term growth, they'll still buy 10-year debt as a safety net, pushing prices higher and yields lower and thus "inverting" the curve.

According to a study from the San Francisco Federal Reserve, an inverted yield curve has preceded all of the nine recessions the U.S. economy has suffered since 1955, making it an extremely accurate barometer of financial markets sentiment. 

Bank of America's closely-tracked Global Fund Manager's Survey suggest around 30% of the more than 360 investors polled see a near-term bear market in stocks, while 12% are predicting recession.

At the same time, U.S. oil prices are trending towards the $100 per barrel mark, a level last seen in 2014, as domestic stockpiles tumble, global demand increases and threats of Russian sanctions put 11.2 million barrels of daily output in question. 

That movement is concerning given that each of the three previous recessions were preceded by big spikes in global crude prices, and Brent futures are up nearly 60% over the past year.

A further indicator of economic decline, although certainly not recession, is the prospect of slowing corporate profits. And while December quarter earnings are on pace to rise by a stunning 31%, that growth will slow to around 6.5% for the current quarter and around 10% for the year, based on Refnitiv forecasts.

Wednesday's data may have shredded this script, however, given that bond markets remain susceptible to the Fed's slate of monthly purchases -- at least until the middle of March -- and oil could retreat significantly if there is a breakthrough in talks to prevent war in the Crimea and sanctions linked to Iran's nuclear ambitions are ultimately eased.

A sustained boom in consumer spending -- fueled by rising wages and, if oil prices slide, retreating gasoline prices -- could also change the trajectory of corporate profit growth. 

Inflation, then, could remain the ultimate 2022 wildcard in terms of both economic growth and broader stock performance.

”US consumers demonstrated that they still have room to spend even in the face of generational inflation numbers! Consumers are spending the savings and wealth created during the pandemic," said Bruce Garner, CEO of Card Curator. "The real question is how long will this continue? With inflation showing no signs of really slowing down, the consumer will continue to be squeezed.”