What is the outlook for bonds amid a potential US recession?

The US recession is still a way off, but the economic outlook remains fragile. 

Investors are being compensated for the wait as bonds continue to have a more attractive risk/return profile than equities.

Can the recession be avoided? 

On the surface, the case for recession seems simple and straightforward: a strongly inverted yield curve suggests that the US Federal Reserve in particular has tightened the monetary policy stance too much.

A steep decline in oil prices points to weakening demand; tightening lending standards will choke off economic activity; and the contraction of the M2 money supply may be a sign of a weakening economy.

Meanwhile, demand for credit has collapsed in response to higher interest rates.

'This time is different?' Probably not.

The regional banking crisis will exacerbate this situation, especially for small businesses that rely most heavily on this channel of credit access.

Historically, a decline in loan demand and a tightening of lending standards occur only a few months before or during a recession.

And yet economic growth in the US for the first quarter of this year was actually revised upward recently.

The US labour market remains strong, and corporate profits and margins have remained robust in the first quarter of this year. 'This time is different?' Probably not.

We expect that, unlike Godot in Samuel Beckett's play, a recession in the US will appear by the end of this year.

Germany – Europe's largest economy – did not escape this recession over the winter months after a mild winter and a sharp drop in energy prices fuelled hopes of escaping it.

Economic output fell by 0.3 per cent in the first quarter, the second successive quarterly fall.

The main factor was weak consumption, which was burdened by high inflation rates.

The weakening in demand was most recently reflected in a greater than expected decline in both headline and core inflation.

Uncertainty about future macroeconomic developments is manifesting itself in high volatility in interest rate expectations.

The broad improvement in the latter indicates that the decline is not only due to mechanical base effects.

This is a welcome development for the European Central Bank.

Although the central bank is likely to have walked a large part of its interest rate path, we do not expect it to prematurely declare the inflation battle over.

This is also true for the other major central banks and the US Fed in particular.

Bonds: credit spreads reflect great optimism 

In any case, central banks themselves provide little guidance to market participants due to their data dependency.

As a result, uncertainty about future macroeconomic developments is manifesting itself in high volatility in interest rate expectations and thus in particular at the short end of the yield curve.