The impressive equity markets’ rally posted so far this year in most developed countries has wrong footed many investors. The battle against uncomfortably rising inflation has forced central banks to massively tighten financial conditions, with notably the Fed embarking on its most aggressive hiking cycle in decades. With economic uncertainty rising and liquidity shrinking, bearish sentiment has markedly increased, with a potential recession being probably the most anticipated in US history.

This is not the message conveyed by markets, however, with risky assets leading the way in terms of performance since the beginning of the year in the US: equities are up about 10% (essentially driven by the tech sector), followed by high yield bonds (+3.6%), investment grade bonds (+2.8%), sovereign bonds (+2.4%) and finally cash at +2%. Clearly the reverse order of what would be typical of a recessionary environment. Only commodities, with a drop of more than 10%, have signalled a prospective downturn in economic prospects, with prices now below the level that prevailed before the Ukraine war.

Mixed messages challenge predictions
So where do we stand? Is this largely predicted economic (hard-)landing coming or is it just an illusion? Economic indicators are sending mixed signals, with firstly a divergence between hard data (actual statistical measures like GDP unemployment rate…, which typically tend to be retrospective) that remain firm, and soft data (business surveys, consumer confidence etc.) that suggests economic weakness and are more forward looking. 

Looking at the latter, amongst the many leading indicators that are commonly used to assess the direction of the economic cycle, the Purchasing Manager Indices (PMIs) are probably the most accurate. As a reminder, these are monthly surveys of purchasing and supply executives of hundreds of firms across sectors, who answer questions related to different sub-categories (production/business activity, price paid etc.) that translate into diffusion indices where 50 is the threshold above which business conditions are improving, and similarly below which they are contracting.