While fears of recession, in particular in the US, have
increased sharply and risk markets have
sold off, the increased likelihood of a recession is not priced in uniformly across asset classes. The uneven
pricing of recession risk is shown in Figure 13.
On average, U.S. equities have fallen 26% during previous recessions. So far, the S&P500 has declined by 20%
from its peak (to June 28th), so equity markets appear
to be pricing in a 20/26=78% chance of a recession.
A similar calculation for Euro area equities, which
were down by 19.2% from their peak to June 28th,
would mechanically imply recession probability of
19.2/26=74%. In Credit, we estimate that the average US HG spread
level during recessions (over the past six) is 250bp
and the average level outside of recession is 100bp.
In Treasuries, wee previously used 5-year spot
yields to proxy the probability of recession by taking
into account that, during the last four recessions, we
had seen an average decline of 200bp in 5y USTs and
160bp in 5y Euro area swaps (measured from the
peak in the months before the recession started to the
trough during the recession). US 5Y yields have in
recent weeks declined by 35bps implying a 35/200 =
18% likelihood of a recession.
While equities,industrial metals and Euro HG credit appear to be
pricing high 75%-80% probability of a recession,
government bond markers price in only 18% risk of a
recession, while US HY credit prices in 34%
probability and Euro HY/US HG credit around 47%.
- J.P. Morgan Global Research
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