global perspectives

2 reasons why recession fears are unjustified

2 reasons why recession fears are unjustified
Samy Chaar - Chief Economist

Samy Chaar

Chief Economist
Florian Ielpo - Head of Macro, Multi Asset

Florian Ielpo

Head of Macro, Multi Asset

In the latest instalment of Simply Put, where we make macro calls with a multi-asset perspective, we defy market fears of a recession.


Need to know

  • Markets are fearful that central-bank hawkishness could trigger a recession.
  • But history shows that short recessions are not typically followed by short expansions.
  • Costs and long-term interest rates remain remain low, indicating that this cycle has longer to run.



Market fears

In recent weeks, markets have started to anticipate that the current cycle may end sooner rather than later. The combination of higher inflation, wage increases, supply-chain issues and hawkishness among central banks have made investors apprehensive. For two reasons, we think these concerns are overblown.


Reason #1: the expansion-recession mismatch

First, markets are assuming that short expansions lead to short recessions. Yet history shows that no such relationship exists. Figure 1 shows that in the US, long recessions are usually followed by shorter periods of expansion. Indeed, an economy enduring a long period of hardship will find it difficult to bounce back and create a sustained expansion. High unemployment, low volumes of investment and sub-par production over a number of years are hard to turn around. On the other hand, short recessions are shown to yield to expansions of variable durations.

With this in mind, we believe current market fears are misplaced. During the covid-19 shock, unemployment surged but was reined in quickly as vaccination campaigns brought the virus under some control. The recession was also short due to immense fiscal and monetary stimulus. Such short recessions tend to be a bump in the road of economic growth, whereas recoveries from longer recessions can be more of an uphill battle.


FIG. 1. US economic expansion duration as a function of recession duration



Source: Bloomberg, LOIM as at November 2021.


Reason #2: costs and long rates are low

Second, interest rates often rise significantly before a cycle turns downward. Figure 2 shows US long-term growth, a proxy for economic gain, and the US 10-year real rate, a proxy for economic cost. In the past, when gains and costs have converged, a recession has followed. In other words, when costs become greater, the economy slows to the point of contraction.

This happened in 2001, when the dotcom bubble burst, and in 2008 before to the Global Financial Crisis broke out. In both instances, investment declined as the economic reward became less than the funding cost. Currently, costs are close to their lowest ever level while gains remain solid and are being supported by the extraordinary consumption growth that we expect will continue to develop in the coming quarters.

Taking this into account, real rates would need to increase by a large margin before recession fears gain real credibility, in our view. At present, only short rates are rising, and companies and households do not fund their investments with short rates. It is only when long-term rates rise that we should really start to worry that the expansion is ending.


FIG. 2. US 10-year real rate versus real potential output growth



Source: Bloomberg, LOIM as at November 2021.


Healthy economies attract hawks

Finally, it is worth remembering that tighter monetary policy is first and foremost a positive economic signal. If a central bank decides to taper its quantitative easing programme and raise rates, it believes the economy is solid. Unemployment is currently low, inflation should start normalising in 2022 as supply-chain disruptions ease, and companies are posting strong earnings. In our view, developed economies are well positioned to withstand rate hikes without blinking – and they actually need this to happen for expansion to prosper.


Simply put, because short recessions are not typically followed by short expansions, and long-term rates would need to rise substantially to signal a likely downturn, we believe recession fears are unfounded. 


important information.

For professional investor use only

This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited  which is authorized and regulated by the FCA. ©2021 Lombard Odier IM. All rights reserved.