INTRODUCTION As inflation continues to trend lower, most central banks appear to be done hiking interest rates. The European Central Bank...
Oftentimes, tighter monetary policy exposes financial excesses and pockets of risk within an economy.
In the current late-cycle environment, this may be the case. Stricter lending standards and stress within the financial sector are not welcomed events. However, with regard to inflation, tighter overall financial conditions should limit credit availability and, in turn, limit consumer and business borrowing and spending.
Central banks appear willing to use the lending channel and a hit to economic growth to bring inflation back to target levels. Does that mean an economic recession is on the horizon in the United States? We estimate that there is at least a 50% chance of recession within the next six months.
Since the banking sector developments in March, financial sector stress and the potential for additional bank failures have drawn investor focus. But in our view, investors should not forget about inflation risk.
 Source: US Bureau of Economic Analysis, as of 30 March 2023.
Credit spreads across several corporate benchmarks have widened to reflect increased risk of a downturn, but have yet to reach their 2023 high point.
Government Debt& Policy
Swift action by US and European governments may have prevented a more protracted financial panic.
The US dollar typically performs well when there are macroeconomic risks bubbling over abroad.
We believe tighter financial conditions, less pricing power and declining margins should lead S&P 500 consensus earnings estimates around 10% lower from the current $220 level.
 Data as of 3 April 2023.
A cautious asset allocation stance with a tilt toward fixed income is warranted in our view given macroeconomic headwinds and a corporate profits recession appearing to take hold.
By Craig Burelle, VP, Senior Macro Strategies Research Analyst
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