WEEK ENDING 3/7/2025
- Recession forecasting is a fraught exercise
- Falling expectations for Q1 GDP
- Unemployment at 4.1%
A CITY DIFFERENT TAKE
Bloomberg currently projects a 25% probability of a United States recession. Bloomberg derives these numbers from monthly and quarterly surveys of various banks. We enlisted everyone’s favorite consultant: AI. Here’s what Gemini (Google’s Artificial Intelligence), Claude AI, and ChatGPT say about recession forecasts:
Gemini:
“There's no single definitive answer; it's safe to say that the probability of a U.S. recession in 2025 is a subject of ongoing analysis and debate. It is wise to stay informed of the changing economic indicators.”
Claude AI claimed it was trained on data as far back as October 2024 and recommends checking the Federal Reserve's recent forecasts.
ChatGPT:
- (Most Likely): Slower economic growth, but not a deep recession. The Fed may cut rates to stimulate the economy.
- Mild Recession (Moderate Risk): If consumer demand weakens significantly or the Fed doesn’t ease policy fast enough.
- Severe Recession (Low Probability): Would require a major financial crisis, geopolitical shock, or deep corporate layoffs.
According to the New York Fed’s recession model, there is a 29% probability of a U.S. recession by the end of 2025.
All these answers range from simply “we don’t know” to somewhere around 25%, which is not a high probability. Now, putting our fixed-income hats on, let’s recap some of the important data points for the economy.
First, GDP growth. Remember, we are coming from last year’s growth figures, which round to 3% almost every quarter until 2025. For the first quarter of the year, the New York Fed has growth projected to 2.67%. However, we are seeing worrisome numbers come out of the Atlanta Fed and their GDPNow forecasting model.
By its admission, this is not an official forecast but a running estimate of real GDP growth based on economic data for the quarter. On March 6, the GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2025 was -2.4%, up from -2.8% on March 3. Other ranges for Q1 GDP are 0–1%. Again, sticking to the trends rather than absolute numbers, the trend for Q1 GDP is trending significantly lower than 2024.
Not to ignore the bond market by any means, but the front end of the curve normally controlled by the Fed has been down sharply. Traders are piling into short-dated Treasuries, pulling the 2-year yield lower. This is assuming the Fed will lower rates. The market implied rate cut for the next year is currently around 79 basis points.
Moving from the market and Fed to the White House. We are getting the message from the Trump administration that the economy faces “a period of transition.” While we are all getting whiplash from the tariff back-and-forth, the stabilizer effect of tax cuts and revenue tariffs has yet to be factored into the economy. For now, the president's team is sticking to the “no pain, no gain” mantra as it implements policy changes.
Consumer sentiment fell in February as we faded from U.S. exceptionalism to tariff uncertainty and the possibility of a U.S. slowdown.
Last Friday’s job report showed an increase of 151,000 nonfarm payrolls. Unemployment ticked up from 4.0% to 4.1%. The disappointing numbers were in hours worked, which declined each of the prior two months. Average hourly earnings grew 0.3%. While these are all good numbers signaling a strong labor market, we are going to see unemployment tick up with layoffs at Walt Disney, Goldman Sachs, and the federal government.
No review is complete without mentioning inflation. To that end, we have core PCE, which is higher month-over-month at 0.3% and year-over-year at 2.6%. This Wednesday, we see the release of CPI data. Bureau of Labor Statistics projects a higher CPI for February.
The market is not expecting any rate cuts from the Fed in its March 18–19 meeting.
CHANGES IN RATES
Yields rallied last week. Other than one-year paper, the rest of the curve showed an increase in the respective tenors.
Interest rates in the municipal market mimicked Treasuries with the rally in yield.
The muni-Treasury ratio range-bound widened slightly week-over-week.
Corporate yields were higher on the week.
THIS WEEK IN WASHINGTON
Trump’s 25% tariffs on Canada and Mexico went into effect last week. However, there was some room for quick compromise, as Canadian energy tariffs dropped to 10%, while auto sectors and goods and services covered under the USMCA trade agreement saw a one-month delay on any tariffs. The exemption is set to last until April 2, after which the president intends to introduce new tariffs and reciprocal tariffs towards countries and sector-specific levies.
Meanwhile, in the House, Republicans have announced a spending bill that should keep the government agencies running through September 30. The bill will be put to vote on Tuesday. Even though neither party wants a government shutdown, if the bill fails, Congress will have to pass a temporary bill to buy some time. The president has asked Republican lawmakers to pass the bill with “no dissent” in the ranks.
If today’s stock market performance is any indication, we can expect much more volatility to come.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of March 7 at 2.52%, 6 basis points lower than Feb. 28. The 10-year Breakeven Inflation Rate finished the week at 2.33%, 5 basis points lower week-over-week.
MUNICIPAL CREDIT
As of March 7, 10-year quality spreads (AAA vs. BBB) were 0.84%, 4 basis points wider than the prior week (based on our calculations). The long-term average is 1.69%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.91%, 3 basis points wider than the prior week. High-yield quality spreads were 9 basis points wider at 2.81% week-over-week.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, money market funds saw increases in inflow across the board. The decrease in fund flow was contained in the tax-exempt funds.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were down week-over-week across most categories except municipals.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced mixed flows. ETF fund flows are tied to the rate volatility that Treasuries are currently experiencing.
SUPPLY OF NEW ISSUE BONDS
The supply of new issues is expected to be closer to $9.8 billion this coming week. The Municipal market has to digest $20+ billion in positive net supply for the next three months. The backdrop against this issuance is Treasury market volatility, budget discussions, and tariff uncertainties.
In the investment grade credit market we saw $74 billion with year-to-date supply at $438 billion.
CONCLUSION
Nonfarm payroll reports from last Friday showed a resilient U.S. economy. However, the underlying data is starting to show softness. Policy uncertainty is also playing out in the Q1 GDP forecast, which has dropped sharply.
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