Macro Scenarios: Resilient US Economy but Downside Risks Loom

Investor sentiment has improved since we last wrote on macroeconomic scenarios in the midst of the banking turmoil. A soft landing still seems possible on the back of strong U.S. consumer confidence, supported by a remarkably resilient labor market and post-pandemic excess household savings. There is geographic fragmentation, however, with China’s post-lockdown recovery potentially losing steam, the U.K. seemingly facing entrenched inflation and the eurozone in a mild technical recession. Furthermore, downside risks remain, with the potential to push economies toward a hard-landing scenario.

Mixed signals from bond and equity markets

Yield curves are deeply inverted across economies while equity-market valuations and corporate-bond spreads show signs of improving conditions compared to a few months ago. Market-implied expectations for monetary policy in the U.S., eurozone and U.K. are now aligned, with central banks signaling further rate hikes in the second half of the year. The big questions for investors are how much economic damage potentially continuing rate hikes might cause and whether the inverted yield curve could portend recession this time around.

We updated our four macroeconomic scenarios to reflect the latest economic forecasts, including those lingering downside risks with the potential to push the U.S. economy toward a hard landing. Central banks might be forced to crush demand and induce a recession to rein in inflation, if it proves too stubborn; an escalation of the banking crisis could cause a dreaded credit crunch; and geopolitical tensions could reduce potential growth and push inflation up. While a diversified portfolio of global stocks and U.S. bonds and real estate could gain 7% under the hoped-for soft landing, it could lose 3% or 9% under our hard-landing and mild-stagflation scenarios, respectively.¹

The authors thank Dora Pribeli for her contributions to this quick take.

Scenario impact across asset classes

Portfolio impact of the scenarios based on market data as of June 28, 2023. Treasury inflation-protected securities are represented by the iBoxx TIPS Inflation-Linked Index provided by S&P Dow Jones Indices. U.S. Treasurys, equities and corporate bonds are represented by MSCI indexes. Private equity is represented by model portfolios. U.S. real estate is represented by the MSCI/PREA U.S. AFOE Quarterly Property Fund Index. The composite portfolio is 50% global equities (35% public and 15% private), 10% U.S. Treasurys, 10% U.S. Treasury inflation-protected securities, 10% U.S. investment-grade bonds, 10% U.S. high-yield bonds and 10% U.S. real estate. Source: S&P Global Market Intelligence, MSCI