Investors are optimistic about the soft landing despite recession worries

Investors are optimistic about a soft landing for the global economy, as evidenced by a recent rally in stocks and bonds. However, there are concerns about a recession as labor markets weaken, the euro zone faces a recession and China's real estate sector struggles.

The US economy grew 5.2% in the third quarter, defying recession warnings. However, unemployment is rising, approaching the Sahm Rule threshold, which signals a recession when the three-month average unemployment rate rises half a point above the previous 12-month low.

The picture is bleaker elsewhere. China grew faster than expected in the third quarter, but manufacturing activity contracted for a second straight month in November. The British economy avoided a recession in the third quarter, but it still did not grow. The euro zone shrank by 0.1% in the third quarter, and a drop in business activity remained widespread in November, suggesting a recession by the end of the year.

Despite these concerns, investors are betting on a soft landing, with expectations of central bank rate cuts next year. The rally has been driven by slowing inflation, which has led to bets on central bank rate cuts next year. A global index of investment-grade government and corporate bonds delivered the best monthly return on record in November. Global stocks also rose about 9%, their best month since November 2020.

Traders have doubled down on 2024 rate cut bets, pricing in at least four 25 basis point cuts by the US Federal Reserve. Expectations are similar for the ECB, which is seen moving first between parentheses in April.

Although the market is optimistic about the economic outlook, there are concerns about corporate defaults, especially in the real estate sector. S&P Global reports that global corporate defaults reached 118 in September, nearly double the 2022 total.

Oil prices have also fallen about 14% in the past two months, partly due to weakening Chinese and European economies. If supply shocks from the war between Israel and Hamas become severe enough to push Brent crude to $150, a level it has never surpassed, a “mild and fleeting” global recession could occur.

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