High inflation is painting the gloomiest economic outlook in 20 years at a time when the U.S. was bouncing back from the pandemic recession —the shortest in history. The Bank of America warned that high prices are bound to get worse and will leave a lasting effect.

Inflation Worries

Michael Hartnett, Bank of America’s chief investment strategist, wrote in a note on Friday: “'Inflation shock’ worsening, ‘rate shock’ just beginning, ‘recession shock’ coming.” The dire warning arrived just before the government’s last report on inflation, which depicted an 8.5% increase in March.

Some of the categories with the highest jumps year-on-year include food, clothing, and new vehicles —the latter due to semiconductor shortages and logistics constraints. Harnett wrote that inflation was “out of control” and underlined that high prices are a key element of recessions.

The markets fear that the Federal Reserve’s tightening monetary policies to clamp on skyrocketing prices via higher interest rates could derail the economy.

Early Signs

Although a recession is yet to be declared, the Bank of America already sees signs of it on Wall Street. Price action has depicted a “recessionary” trend as, according to Harnett, key economy sectors such as home builders, retail, and automotive, have been affected by sharp drops.

The bank released a surveyed-based report stating that investment fund managers were curving their expectations of global growth, as well as profit estimates, which dropped to their lowest since March 2020 —and closer to those during the dot-com boom in 2001 and the crash in 2008.

The first week of April saw the first global bank predicting a recession, the Deutsche Bank, which foresees that the Fed’s measures will send the economy into a “mild” slump by the end of 2023.

The Yield Curve

The U.S. yield curve has inverted in the last week, which means that short-term debt is more profitable than long-term debt. According to economic theory, in a normal situation, long-term lending should be more profitable than short-term lending, since the longer the time, the greater the uncertainty of what might happen.

The anomaly occurs when investors do not trust the future of the economy in the short term and demand a higher remuneration from the issuer of public debt.

A study by the Reserve Bank of San Francisco shows that in the last 60 years, the inversion of the yield curve has occurred 10 times. In the past, this phenomenon was preceded by about a year every slowdown in the US —except for 1966.

What History Says

Although rate cuts are often associated with an economic slowdown, this is not always the case.

In 2019 —and previously during 1995 and 1984, as well as in the 1960s— the Federal Reserve switched from raising interest rates to lowering interest rates to prevent an economic slowdown from turning into a full-blown recession.

Also, the yield curve inversion has not been a good “sell signal” for stocks and credit in the past. The previous expansion ended due to the impact of the COVID-19 crisis and not due to an economic deterioration predicted by the yield curve.

If the rate hikes happen as expected, the U.S. economy will have all the hallmarks of a late cycle and will not have a large cushion to guarantee GDP growth, TwentyFour AM associate Mark Holman explains.

“This is the typical late-cycle position that investors face,” he concludes.