Fear and doubt cloud US and UK economic forecasts

What’s the collective noun for economists? In the current environment, you could be forgiven for thinking it’s ‘a gloom’.

Every quarter since the late 1960s, the Philadelphia Federal Reserve Bank has been asking economists about the US outlook. Included in their list of questions is the anticipated probability of negative GDP growth (a recession) in the year ahead.

The Q4 survey, released a couple of weeks ago, was possibly the gloomiest on record. The collective wisdom of that particular crowd thinks there is a 47% chance of US GDP shrinking in the first quarter of next year. Even more remarkably, there’s a perceived 43% chance that the economy will still be shrinking on a quarterly basis this time next year. That’s the dark red line in the chart below; by a wide margin, the US economics community is the most pessimistic it has ever been.

Has the gloom been priced in?

It’s reasonable to think that if pessimism is this widespread then much of it is already reflected in market pricing. We have regular debates about whether a recession is already priced in. We think the answer is “no, not yet” when looking at credit spreads, equity-sensitive sectors and the US yield curve.

But the pervading gloom, which is also reflected in the downbeat year-ahead outlook published in recent weeks, makes us reluctant to aggressively sell risk in anticipation of the turn in the cycle. If next year does see a US recession, it will be the most telegraphed in the last 50 years. Prices are set at the margin.

We still think next year will be a struggle for asset returns, and are looking for the best way to lighten up risk after the rally of the past two months. But to have a very negative market (as opposed to economic) outlook, we have to ask what new information is going to draw out motivated sellers.

UK economic forecasts mired in uncertainty

Turning to the UK, economic forecasting is hard enough with the impact of recent domestic political turmoil and Russia’s invasion of Ukraine to consider among the more routine analysis. But a few things last week highlighted how difficult this task really is.

First, are the shifting data sands on which any forecasting castle has to be built. Last week we learnt that statisticians can’t count people and they can’t measure prices.

Net migration over the 12 months to June was 504,000¹ (around 0.8% of the population). That’s more than double the operating assumption of the Office for National Statistics and the Office for Budget Responsibility. We also learnt that producer price inflation (PPI) has likely been understated by nearly two percentage points because of a simple data processing error.²

It’s hard to come up with a sensible growth forecast without an estimate of growth in the labour supply. It’s also hard to come up with a sensible inflation forecast without an understanding of pipeline pressure through the supply chain. We’re trying to forecast the future, but it’s impossible to have much confidence about the recent past when it is so badly measured.

Our view on the UK

That’s enough of moaning about how difficult it is to have a view – what are we currently thinking on the UK?

We’re neutral on real and nominal government bonds yields, but we are overweight sterling investment grade credit and are positioned to capture any appreciation in sterling.

Pessimism about the UK outlook is still apparent in the premium still available on sterling credit, and the willingness of investors to potentially overpay for downside protection on the exchange rate.

1. ONS, November 2022

2. ONS, November 2022