Investors should not make economic recession their 'base case', J.P.Morgan says

Equity strategists at J.P.Morgan reiterated their view that clients should not adopt an economic recession in the US, nor in Europe, as their 'base case'.

They conceded that the interest rate spread between two and 10-year US Treasury debt had narrowed significantly, leading to what market observers termed a 'flattening' in the interest rate curve.

It was also true, they said, that the Treasury curve was one of the best leading indicators of recession.

Nevertheless, typically recessions did not start before the curve inverted, nor hand the entire curve flattened, the analyst team led by Mislav Matejka said.

For instance, the interest rate spread at the three-month and 10 year tenors had in fact undergone a strong steepening, and that spread too had been a clear leading indicator of recessions in the past when it inverted.

Curve inversion simply means that shorter run rates move above longer-term ones - which was not yet the case.

As well, curve inversions were good predictors of looming recession because they reflected tighter financial conditions.

Yet this wasn't the case either.

When adjusted for inflation, or in so-called 'real' terms, during past inversions interest rates had been at 200 basis points, whereas at the moment they remained negative and bank lending standards continued to ease.

"In our earlier report on the likely implications of Fed tightening, we argued that the start of hikes is typically accompanied by some market volatility, but this initial weakness ultimately gets absorbed, and the market moves higher. We still believe that recession should not be seen as a base case, even in Europe," Matejka added.

As for the stock market, historically it tended to peak about one year following an inversion with the S&P 500 gaining 15% in the meantime.

"The clock has not started ticking yet, and the upcoming quantitative tightening could matter for the timing, delaying proceedings."