Over the last month, while US equities have made new highs, US bond yields have also fallen simultaneously. US 10y yields have declined by more than 30 basis points since the end of July and the market is now pricing nearly three Fed cuts in 2025 and three more in 2026. US equities are pricing in a resilient growth outlook along with a larger macro dynamic in recent weeks of bond market’s continued shift towards pricing a more dovish Fed. The contrast between continued equity market gains and lower yields looks like the two markets are pricing different economic realities, with bond markets more focused on growth weakness than equities. Risk assets have embraced the idea that Fed easing will boost growth and earnings next year. However, this incorporates confidence that either the recent slide in employment growth will be reversed or that a near-jobless expansion can be sustained. While firming job growth is incorporated in our baseline forecast, recent labor market indicators and business surveys do not send an encouraging message. Moreover, a quick rebound in job growth would likely alleviate recession concerns and generate less need for the Fed’s insurance than markets currently bank on. We see risks on two fronts now. The first is if something causes the market to worry more about recession, especially given current resilient growth pricing. The central macro question now is whether the labor market slowdown morphs into a recessionary dynamic. The second risk is that if growth holds up, the market might worry that it has priced too much Fed easing. We looked at major US economic indicators current levels and compared them to 2008 recession levels. While business capex and confidence is still non recessionary, construction sector & employment indicators are indicating recession. The central macro question at the current juncture is whether the labor market slowdown morphs into a recessionary dynamic. The quickest way for the market to worry that it has misjudged the limited nature of near-term economic weakness is a sharper rise in the unemployment rate. That scenario would lead the market to pull forward cuts and put equities under pressure. Hence, we believe it is time to put on hedges for exposure to risk assets. Recession or not, next few months might see IVs exploding across both equities & bonds.
