U.S. recession risks rise as Ukraine-Russia add to inflation, some strategists say

Mar. 20, 2022 10:31 AM ETBy: Liz Kiesche, SA News Editor79 Comments

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Concern about a U.S. recession in 2023 is growing, Goldman Sachs economists said in a recent report. Investors are getting nervous that surging inflation, exacerbated by the Ukraine-Russia conflict, will derail the 22-month-old U.S. economic recovery.

They're not the only ones. Morgan Stanley strategists point to a "hotter and shorter cycle."

S&P 500's decline in recent weeks suggests ~40% likelihood of a U.S. recession, which would lead to lower valuations and earnings, according to Goldman Sachs Research. Separately, the firm's economists, led by Jan Hatzius, estimate a 20-35% chance of a U.S. downturn over the next year, roughly in line with models based on U.S. Treasury yields.

"While our baseline forecast assumes that further service sector reopening and spending from excess savings will keep real GDP growth positive in the coming quarters, uncertainty around the outlook is higher than normal," they wrote.

The Goldman economists downgraded their U.S. GDP forecast to 1.75% in 2022 from 2.0% previously to reflect higher oil prices and other factors relating to the Ukraine war that will drag on growth. Also, "our financial conditions index has tightened somewhat further since the start of the war in Ukraine, implying a more negative growth impulse," the economists said.

"We're hurtling toward an environment of tighter policy decelerating EPS growth, and more tempered risk asset returns," said a group of Morgan Stanley strategists, including Andrew Pauker, Serena Tang and Michael Wilson, in a March 18 note.

Already signs of slowing are occurring, they said. Morgan Stanley's cycle indicator aggregates key cyclical data to get a sense of where the economy is in the cycle and where headwinds/tailwinds exist by asset class. Its model is currently in the "Expansion" phase, with data above-trend and rising, indicating that the economy is in the mid to late-cycle. "At current pace, the indicator could peak in 2-4 months and move to 'Downturn' in 5-10 months from where we are now," the Morgan Stanley strategists said.

The Morgan Stanley strategists suggest that investors equal weight global equities, favoring rest of the world over U.S.; equal weight credit with high yield over investment grade; and overweight commodities and cash funded by underweighting government bonds. For U.S. equity strategy, they suggest defensive cohorts, such as food/beverage/tobacco, insurance, utilities, real estate, telecom, and pharma.

J.P. Morgan's Marko Kolanovic isn't seeing a large risk to a recession. In a March 17 note, he observed that equity sectors including innovation, tech, biotech, and emerging markets "are already pricing in a severe global recession, which will not materialize in our view."

Still, he doesn't rule out the possibility of a recession in Europe and further slowdown in the U.S. "From the time we called the bubble these segments are down 60-80%, which we think is the end of the correction and in some areas represents a liquidity-driven overshoot," Kolanovic wrote.

He advises investors to start adding innovation and tech stocks that have been beaten down, and he remains bullish on commodities and commodity equities.

Looking at the global economy, Moody's baseline forecast sees Russia's invasion of Ukraine reducing global economic growth projections but not derailing the expansion. Moody's analysts now expect G-20 economies to expand 3.6% vs. 4.3% growth it had expected in its February outlook. "Russia is the only G-20 economy that we forecast will contract this year," the analysts led by Madhavi Bokil, senior vice president/CSR, wrote in a March 17 note.

For the U.S. economy, Moody's lowered its real GDP growth projections for 2022 to 3.7%, down 0.6 percentage point, and for 2023 to 2.5%, down 0.2 pp.

Moody's also give alternative downside scenario where the global economy could tip into recession. Under one, oil and gas exports from Russia to Europe are cut sparking a surge in oil prices. In another scenario, the global economy would suffer if the Russia-Ukraine military conflict widens to other countries. In addition, new waves of COVID-19, monetary policy missteps, and social risks could dampen global economic growth.

SA contributor Cullen Roche sees energy price surges and the flattening yield curve increasing the risk of recession.

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