Goldman says recession risks are growing, but it's too early to worry. Here's why

Published Sun, Apr 17 20228:16 PM EDT

Lucy Handley @in/lucy-handley-b2b0a61a/@lucyhandley

Goldman Sachs says the risks of a recession are growing, but it's too early for "recession obsession." "With elevated inflation, slowing growth from the Covid rebound and a historically tight labour market, stagflation concerns remain high among investors. And, with the Fed embarking on one of the steepest hiking cycles since the 1990s, there are also growing concerns over recession risk," Goldman analysts, led by Christian Mueller-Glissmann, stated in an April 14 research note. In the note, entitled "Growing Risks But Too Early For Recession Obsession," the analysts considered a number of market indicators, including the closely-watched 2-year and 10-year Treasury yields, to assess the probability of a recession. Usually, investors would expect a longer-term bond to yield more than a shorter-term one, but at the end of March the rate of the 2-year note was higher than the 10-year's . This inversion is seen by some as a sign of a forthcoming recession. (Click here to monitor the spread in real time.) "Since the late 1980s the time lag between US yield curve inversion and US recessions has been on average 20 months," Goldman's analysts stated. The other indicators Goldman looked at include the volatility index, or VIX, and the excess bond premium (EBP), a measure of investors' appetite for risk. While these indicators spiked in the first quarter because of the Russian invasion of Ukraine, as well as concerns over the Fed tightening monetary policy, they have now declined "materially," according to Goldman's analysts. Currently, there is a market-implied recession probability of 20% to 30%, the bank said, and historically that has resulted in a recession 28% of the time within 12 months. This is "broadly in line with our economists' assessment of the risk of the US entering a recession over the next year," Goldman said. "While the recession probability embedded in leading market variables has increased YTD, it still points to a relatively low level of risk," the bank added. Market implications Mueller-Glissmann and colleagues noted that predicting the timing of recessions is notably difficult. "Market-implied recession probabilities can help but investors need to balance the 'time in the market' with 'timing the market' as divesting too early can mean giving up positive equity returns," they wrote. The bank remains overweight equities in its asset allocation, but said it is focussed on "managing risks with tail risk hedges." It is also overweight commodities and cash, and underweight bonds and credit. "While we acknowledge the combination of geopolitical uncertainty and hawkish policy increases the risk of a correction even without a recession, we still think equities stand a better chance of beating inflation in the long run," Goldman stated. - CNBC's Patti Domm contributed to this report.

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Goldman Sachs says the risks of a recession are growing, but it's too early for "recession obsession."