Inflationary cycle leading to Recession now

A new report out today warns that the economy may be contracting. This morning’s Services PMI report from the Institute for Supply Management was a complete disaster. The U.S. Services PMI came in at 48.8%, down from 53.8% last month and from 53.9% this time last year. That’s a nearly 9.5% drop year over year. What does this mean? It seems that the fastest rate-hiking cycle in history is starting to have an impact… and it’s not good. To explain my argument, we need to dive into the services data and why it matters. What Is the ISM Services PMI? The Institute for Supply Management Services PMI is a monthly, survey-based indicator of activity in the U.S. services sector. The index, which gathers economic information from more than 15 industries, including healthcare, finance, and retail, monitors business conditions by tracking five variables: Business activity. New business. Employment. Inventories. Supplier deliveries. It’s an important read on future economic activity, and ultimately on inflation or disinflation going forward. Generally, a reading above 50 signals growth and below 50 indicates contraction. Historically, this tends to be a leading indicator for both the economy and the stock market. Weakness tends to precede recessions, as it suggests corporate profit growth is likely to underwhelm or turn negative. This also ties back into the movement we’ve seen in Treasury prices and yields this week. Services PMI and Treasurys: A Recession Warning Now, it seems like the spike in yields this week in Treasurys was just a fake-out. The lower services reading spiked odds of a Federal Reserve rate cut. However, it’s important to remember that the Fed’s actions have delayed consequences. Once the central bank cuts rates, it will take several months to feel the effects. It’s also important to note that this is not a guarantee that the Fed will cut rates. In fact, it has good reason to NOT do so, based on credit spreads indicated almost no default risk. But what if credit spreads are currently mispriced relative to the probability of a recession. If this is the case, the Fed has been fooled and a recession is coming. At the very least, investors should buckle up for the next three months. A great deal of volatility is ahead.