Is recession around the corner?

Linda Duessel: Hello and welcome to the Here & Now podcast from Federated Hermes. I'm Linda Duessel, senior equity strategist. Today's episode is a special recording of a round table discussion I led with my Federated Hermes colleagues, Steve Chiavarone, senior portfolio manager and head of Multi-Asset Solutions, Silvia Dall'Angelo, senior economist, and Donald Ellenberger, senior portfolio manager and head of Multi-Sector Strategies on October 11th. For those who are not as familiar with Federated Hermes, I'll give you a brief introduction to our company. Federated Hermes is a global leader in active responsible investing with more than 600 billion dollars in assets under management. At Federated Hermes, responsibility is central to our client relationships, our long-term perspective, and our fiduciary mindset. It's part of our heritage and the foundation of our future. Our investment solutions span equity, fixed income, alternative/private markets, multi-asset and liquidity management strategies. And with that, please enjoy this special episode.

Today we will discuss what everyone's talking about, recession. Is there recession around the corner, that's the title of our discussion today. And I think I'd like to start out with, well, is a recession around the corner maybe has a lot to do with whether or not we can beat what looks like it's become a structural global inflation problem. So let's start with you, Don. In representing the bond department at Federated Hermes, how's the Fed doing? Obviously they're behind the curve. Are they going to tighten too much, fastest pace ever?

Don Ellenberger: So the Fed realized they made a mistake and so they are tightening very aggressively, as aggressively as they've done since the 1980s. And they tell us that they can sidestep a recession, Linda, and deliver a soft landing as they try to slay the big inflation dragon. But remember, this is the same Fed that told us inflation would be transitory. The Fed is really faced with a terrible choice, runaway inflation or recession. I think this soft landing is going to be really hard to achieve because the Fed's two main tools, the Feds fund rate and their balance sheet are just too blunt and inflation is just way too high to pull off a soft landing. And history clearly is not on the Fed's side. Whenever inflation has been above 4% like it is now and the unemployment rate has been below 5% like it is now, a recession has followed within two years every single time.

The Fed has never been able to engineer a soft landing when inflation has been this high, the labor markets this tight, not once. And I think that's because inflation lags the economy. Inflation keeps rising for about a year even after the economy has rolled over. So since the Fed is chasing something that lags the economy using blunt monetary policy tools that work with long and variable lags themselves, it's no surprise that the Fed has never been able to successfully engineer a soft landing when inflation has been way above target like it is today.

Linda Duessel: They do have a very difficult job and you don't paint a very pretty picture. Of course, they're students of history too. Are they tightening though at the fastest pace ever? And now why would they do that? Because you did mention a delay on hitting the economy. What kind of delay are you talking about? How does that make sense that they'd go so fast and so hard?

Don Ellenberger: Inflation is 8.5%. Let me say that again. Inflation is 8.5%. After 40 years of not being able to get it to 2%, it's 8.5%. That's why the Fed is going so hard. They feel like they're losing credibility and they have to get it back and they're willing to risk a recession to do that.

Linda Duessel: And so when do you think it'll start to be felt in the markets then or in the economy rather?

Don Ellenberger: Well, we know that monetary policy works with long and variable lag, as Federated Hermes has famously said, I think it shows up next year.

Linda Duessel: I'll turn to you now, Steve, head of our multi-asset team and I know you have a series of dashboards to help our clients and our inflation dashboard I think called for a problematic and non-transitory problem probably early on in this situation. And so now what are you thinking? Soft landing recession or something in between?

Steve Chiavarone: There's always a chance of a soft landing. I'd like to say I've got a better chance of being a center in the NBA. To Don's point, I'd go a step further and say that I think a recession is not something that the Fed is risking, it's not a bug at this point. I think it's a feature of their policy. If you go to the doctor and the doctor's going to do something, they always say, 'It's only going to be a little pinch.' They never say, 'What I'm about to do is extraordinarily painful.' Well, the Fed chair looked in the camera and said, 'I'm going to deliver pain and that pain's going to be a higher unemployment rate and it's going to be a housing market correction.' That's a recession. That is the cure that they're prescribing here to the inflation problem.

And I think as we look at our inflation dashboard, what it has shown us early on and continues to show us is that this inflation is pervasive and it's persistent. Even as good prices or various good prices have eased in the past, the core readings have continued to move higher. And as we look out, I know we'll touch on this a little bit, I do not think that we can say with a hundred percent certainty that we have yet seen the peak in headline inflation or core for that matter, which means that there's still risk posed by inflation and still risk of ever tighter monetary policy here.

Linda Duessel: And so I wonder, Steve, as we watch the Fed in their resolve, I was a child of the '70s and I remember the '70s, they were battling an inflationary problem throughout the '70s until Paul Volcker came in and we suffered a pretty tough recession at the end, numerous recessions but a really tough one. So when we talk about obviously we're going to have a recession, is he going to get a full Volcker do you think?

Steve Chiavarone: Well, I think he's trying to not do what Burns did, which was, you're right, the Fed in the early '70s did hike rates and then you got the '73, '74 recession and they cut, in retrospect, too early and too aggressively before inflation had been crushed, which meant that with that recovery it reaccelerated and it reaccelerated to new highs. And that's the playbook that we think is in their mind, which is to say, 'Okay...' And this was the difference in the last press conference, right?

Prior to the last press conference, every economic projection that the Fed put out was sourced in Candyland, right? Taking inflation from 9% to 2% with no increase in unemployment, no recession. I think the last set of projections said, 'Yes, unemployment is going to go higher, growth is going to go lower, a soft landing is going to be more challenging and that's not going to stop us from taking rates higher and keeping them there for some time.' I thought that was a key difference and I think it was a callback to not to repeat the errors of the mid '70s. The question now is will they have the resolve to actually do it?

Linda Duessel: Right. Will they have the resolve? And Silvia, I bring you in as you are our economist for all things international. The Fed has said, and Steve ends with an interesting comment, 'Will they have the resolve to keep doing that?' Now well, the Fed is raising interest rates, our already strong dollar keeps getting stronger and stronger, and as you watch central banks around the world, other developed economies' central banks who feel that they need to raise their interest rates, they have, in many cases, a much tougher economy, don't they? Is there a risk for other central banks that our Fed seems to continue with some sort of a resolve here?

Silvia Dall'Angelo: Well, I think that the risk from a stronger dollar goes beyond other developed central banks. Clearly, the Fed is laser focused on domestic inflation and correctly so. I mean that's their mandate. But a strong dollar is a problem for the rest of the world really. A strong dollar means tighter financial conditions globally. Many emerging markets are still financing themselves in dollar and so a stronger dollar just is impairing their access to credit and so their growth outlook.

From the perspective of developed central banks, well, I will focus on Europe where central banks are facing way more difficult trade-offs between inflation and growth. Inflation in Europe is mainly driven by the terms of trade shock due to higher energy prices and the consequences really of the war in Ukraine. And this weakening of their currencies that they're witnessing because of Fed tightening really is just making their problems worse as it is also adding to this deterioration of their terms of trade. So I think that from the Fed's perspective, this is not their problem until it becomes their problem as I think at some stage there will be some feedback effects from these external spillovers.

Linda Duessel: Well, Don, yes, we like a strong dollar but not too strong of a dollar and maybe we're having that right now. Should the Fed consider slowing down their tightening efforts in the name of the dollar coming down on a trade weighted basis, should they be doing that?

Don Ellenberger: So the dollar impacts financial assets in many ways as Silvia so correctly pointed out and the Fed obviously does need to keep an eye on it, but you have to remember that technically the dollar is under the purview of the Treasury Department, not the Fed. Now having said that, the dollar's 12% rally on a trade weighted basis this year is actually I think good news for the Fed because that means we're exporting inflation overseas and it helps the Fed's battle to get inflation back down to 2% here in US. But it also creates some difficulties for the treasury market. The stronger dollar has made it much less attractive for foreigners to buy our treasury bonds because currency hedging costs have just skyrocketed.

The Japanese investor who buys a US treasury bond with a 4% yield here and hedges it back into Yen, actually will wind up with a negative yield. So to the extent the strong dollar helps to both reduce US inflation and it keeps rates higher, tightening financial conditions, which is the Fed's goal, then I think the Fed is happy with a strong dollar and they're not going to stop because the dollar has gone up. They're more focused on getting inflation down and a strong dollar helps that.

Linda Duessel: Well, it's a big mess, Silvia. It's a big mess that we're painting here today and we've yet to talk about winter, which is coming, isn't it, in Europe. And as you sit over there in London, gosh, good luck over there with the cost of energy. So what should we expect? Now we've been reading that Europe is working on filling up spare capacity, bracing itself, maybe bracing its citizens. Is there going to be a really bad recession because of the energy crisis that's going on over there?

Silvia Dall'Angelo: Well, I think at this stage a recession is inevitable in Europe due to the increase in energy prices. Just to put things in perspective, wholesale gas prices that have come down over the last few weeks, are still 10 times higher than they were in 2020 and previous year so before all the stress started around the middle of 2021. So it's a massive energy shock that happened in a very concentrated timeframe and looking at the winter, well, my base case is really for a recession basically has probably already started and we'd like to continue at least until the end of the first quarter of next year. Again, in my base case, I have a contraction in Eurozone GDP of about 1% peak to trough. And again that assumes that winter is normal and so the Europeans will manage to balance their gas market really. And the problem there is that, well, basically the European Union used to import about 40% of its gas from Russia.

Since at least June, they started to scramble and step up their programs to replace the Russian gas with alternative sources, mainly LNG from the US and Qatar, but also some piped gas from Nigeria and Northern Africa. They have managed to largely replenish their storages which is good news and clearly a good buffer looking ahead, but they also need to achieve some energy savings. And so gas demand needs to decline by about 15% compared to last year, between now basically and March, so during the winter season, which means that really there's basically no margin of errors from a European perspective when we look at the energy market. And if we have a severe winter or a lack of coordination in achieving those savings, I mean the risk is that we have even an even harder recession in the years on this winter.

Linda Duessel: I presume that the populations over there are braced, presume that's all everybody's talking about, and doing whatever they can to prepare?

Silvia Dall'Angelo: I would say that there are different levels of preparation. So as I said in European Union, all the plans have been stepped up in the summer when basically Russia first started to tinker with the daily supplies, going through Nord Stream 1. And the public opinion is well aware of the issues. Over here in the UK, there has been less of a preparation in recent months and even recently the government has denied that there would be a need to basically cut electricity consumption during the winter. That said, anecdotally, households are getting ready and recent retail sales data show that households are bulk buying blankets, warm clothes, and also energy efficient appliances. So people are getting ready for a tough winter.

Linda Duessel: Okay, well, Steve, energy certainly has been weaponized, hasn't it, all around the globe? So as stock market investors and the energy patch, I know has been that energy sector's been a great place to invest now for a couple of years and their earnings look spectacular. So what would you say? I mean people are torn. Okay, if we're going to have a global recession then maybe we should avoid energy. But if there are supply problems, should we then overweight energy. Where do we stand on that?

Steve Chiavarone: We're neutral for that reason, Linda. I mean the classic recession play is to be underweight the sector, but with the supply constraints that are coming and the OPEC production cut, it's hard to get too short. And so we've taken profits and we're generally neutral across portfolios.

Linda Duessel: Yeah, I guess that's the sensible thing. When you can't read a binary situation, what else can you do now? Silvia, as the energy patch has gotten itself weaponized, and Steve just mentioned the OPEC production cut, how should we be feeling about that as the United States, asking for some help over there and then they do exactly the opposite?

Silvia Dall'Angelo: As you and Steve have just said, I mean, it's really an energy war and so it's hardly surprising that the OPEC, so including Russia, is responding to some of the moves by the West to try to put a cap on oil prices. And I think that going forward that the situation is not going to change and as Steve said, it's going to be really about how demand will pan out and the wild card there I think is China where we might see a bit of a growth rebound if they lift the Covid restrictions. But again, I think from another perspective, it'll be hard to maintain prices above 90 dollars a barrel in a deteriorating demand environment.

Steve Chiavarone: And Linda, this is a key point for the inflation outlook and where the inflation dashboard comes into play because with core inflation having continued to rise since the last peak in headline CPI, and I think we're going to find out tomorrow that it rose a bit further, you really only need a mid 90s price in WTI in December, which is 3 or 4 dollars higher than it is today in order to get headline inflation back above that 9.1% peak we saw earlier this year. And then that changes a lot of equations. The market feels pretty comfortable about a 4.5% terminal rate. Well, not if you get a new high end inflation perhaps. And I think the Fed can't back off in that environment because if they throw the fastest rate hike cycle ever at this inflation problem and fail to break its back, what happens to inflation expectations? They could become unordered. So this energy issue is in fact central to the inflation call, which is central to what the central bank's going to do, which I think increases the risk of recession as we get into '23 per Don's original point.

Linda Duessel: Again, a big mess. Now Silvia, 90 dollars is just a few dollars away, as Steve has said. That exacerbates our, 'We wish we thought we had peak inflation problem.' If China, the second largest economy in the world decides, 'All right, we have enough vaccines or whatever, we can open up our economy,' are we right back at 110 dollars and plus on a barrel of oil?

Silvia Dall'Angelo: I mean base case, I doubt it's really. So if China lifts the zero-Covid policy that is currently in place, then of course it will be a bit of a technical growth rebound for sure, but I don't expect a growth boom given the structural challenges that the Chinese economy is dealing with. And here really I'm thinking about property sector that is bloated. It used to account for like 25 to 30% of the economy compared to a usual weight of 15%, maximum 20% of the economy in more normal situations. So that property sector needs to correct. The correction will happen over several years. Policy makers will try to smooth it out, but that makes me a bit cautious, let's say, with respect to Chinese growth in the next few years.

Linda Duessel: I'd like to move over to you now, Donald. The title of our call today is a recession around the corner. And I know that a few months ago there was a big debate as to whether or not we're already in a recession, the technical recession, two negative quarters year over year. How can you be in a recession when the job market is as tight as a drum? Are we in a recession right now, Don?

Don Ellenberger: Well, right now Atlanta fed GDP growth is over 2% so probably not, but there are a lot of reasons, Linda, why I think a recession is coming next year. For example, the index of leading economic indicators, which is actually a pretty good indicator predicting recessions and I don't think gets enough attention from investors, but the index of leading economic indicators has been negative for six consecutive months. And I'm an old timer, so I still follow money supply like I did back in the '80s. The growth rate of money supply has collapsed from 26% a couple years ago to basically flat over the past three months. And the big drop we're seeing in bank deposits right now means money supply growth will probably soon turn negative. The last time money supply contracted on a sustained basis was during the Great Depression in the 1930s.

Yield curve, also a very reliable inflation indicator, and it not only has been inverted for months, but the forward curves predict it'll stay inverted for at least another year. Global Purchasing Managers Index, that's fallen below 50, indicating a contraction in the global manufacturing sector. You can even see that in the cost to ship a container from China to Los Angeles has fallen from 14,000 dollars in January to 2,000 dollars today. The economy is also going to have to deal with the lagged impact of the most aggressive Fed tightening cycle in 40 years. The Fed can't really address these supply issues so they're trying to suppress aggregate demand. And what's driving aggregate demand and what I think is the biggest imbalance in the economy today is the tight labor market. So two-thirds of the cost of most companies is labor. The only way to get the inflation rate down to the Fed's 2% target is to get labor costs done.

And the way you do that is by driving the unemployment rate up. The Fed knows that and it's why they're forecasting the unemployment rate's going to rise nine-tenths of a percent from 3.5% today up to 4.4%. But here's the thing, every single time the unemployment rate has risen five-tenths of a percent, the economy has always fallen into recession every single time. So the Fed by telling us they expect the unemployment rate to rise nine-tenths of a percent, the Fed is either subtly or perhaps unwittingly telling us that a recession is coming. So here's another way to think of it, okay? GDP growth was basically zero for the first nine months of this year. So how in the world is GDP growth going to be positive next year with housing now rapidly contracting and the Fed that's hell-bent on pushing the unemployment rate up?

Linda Duessel: This has occurred to me for quite some time now, is that again as a child of the '70s and what they called back the Dismal Decade back then, a terrible beast of inflation to be fought, I think there are similarities now and maybe the non-similarities are even more scary right now. And yet anybody that's 50 years or younger that isn't really paying close attention doesn't really know what that would feel like or what it might feel like. And I can recall, Don, in the recent say 10 years or so, we were all joking, 'Well, the Fed never allows us to go into recession again. The Fed always came to the rescue, didn't it?' But not this time, huh?

Don Ellenberger: No, I don't think the Fed can come to the rescue because inflation is just too big of a problem and I don't think the Fed would consider a recession next year as the worst possible outcome if that meant they were able to get inflation back under control. I would not underestimate Jerome Powell's determination here. He wants to avoid the stop and go monetary policy of Arthur Burns so that he doesn't have to use the scorched earth policy of Paul Volcker.

Linda Duessel: So now, Steve, give us something positive here. Come on, we're looking for something positive to say here because... Whoa, whoa, whoa. I'm going to take you down the path.

Steve Chiavarone: Yeah.

Linda Duessel: The JOLTS Report came out and the number of job openings just absolutely plummeted. And I read some articles, some more up beat people saying, 'Hey, this is good. This is what the Fed wants, reducing the number of jobs and maybe not having to have too high of an unemployment.' Is this a pipe dream?

Steve Chiavarone: I think it is. I'd say what's positive is you've got a stock guy and a bond guy agreeing in lockstep. I mean if it's not positive, it's at least rare, right? No, on average in the 20 years prior to the pandemic, you had roughly 5 million more unemployed workers in the economy than jobs that were available. That was the equilibrium level that yielded a 2% wage inflation number. Oh, that's positive. Today we've got 5 million more job openings than we do unemployed people. That's an imbalance of 10 million jobs. Even if I assume that there's some double counting in those job openings, which I think there likely is, I still have an imbalance of about five, five and a half million jobs. I think that's the increase in the unemployment that's ultimately required to get back to a 2% inflation. Well, on a 150 million person labor force, that's taking the unemployment rate, not from 3.5% to 4.4%, but something closer to 6% or 7%, which I think is ultimately where that kind of has to go.

Linda Duessel: 6% to 7%, when? Will that damage be done by next year end do we think?

Steve Chiavarone: No. So I think it's going to take a while and I think that's why the Fed is signaling that they're going to keep rates high for a while because the experience of companies that did lay off workers in 2020 was it helped for a month and then they spent two years trying to hire them back. And so the Fed is afraid that in a quick pivot people will try to wait them out and hold onto those workers. So by communicating that they're going to keep rates high through '23, we'll see if they actually can, but in communicating that, I think they're trying to tell employers, 'It's not going to get better anytime soon. The pain's going to be in place for a while, cut your labor costs down.'

Linda Duessel: If not a dismal decade, a dismal outlook for some foreseeable future. Now Steve, is a recession appropriately priced into the equity market?

Steve Chiavarone: No. No. I mean I think what you'll see is that historically the average recession decline in an equity market is somewhere in the order of 30, 35% down off of a peak at P/E levels that are really in the kind of 13, 14 times range. Today we're down roughly 25%. I think the trailing P/E is still something like 17 times. I think there's still a desire for tech and high beta to run every time there's a whiff of something that's right. And I think from a sentimental perspective, and I'll close it there, this market's been calling for a Fed pivot and a rally the moment they started hiking in March only to be Charlie Brown with a football four or five times this year. And I don't think that sentiment has yet been crushed regardless of what the sentiment surveys purport to say.

Linda Duessel: Don, is the recession priced into the bond market? Here, I'm thinking of credit and particularly the high yield market.

Don Ellenberger: No, Linda, it is not. High yield spreads are about 300, no, let's see, 535 basis points over treasury. That's where they closed on Friday. 535 is nowhere near the peak you get in recessions. It's typically about a thousand basis points over treasuries. Likewise, investment grade corporate spreads closed last Friday at 142 basis points. They typically go to about 250 and typically you see a flight to quality buying of treasuries. Treasury yields are dropping in a recession, not rising as they have been this year. So the short answer is no, no recession priced into the bond market.

Linda Duessel: So we are steering clear of credit at Federated Hermes in general, are we, and what part of the curve should we buy? When is it interesting to start going out long on the yield curve?

Don Ellenberger: Well, I think you want to avoid credit for sure. I think you want to stay up in quality. We like treasuries. In terms of, 'Is now the time to extend?' It really depends on what you think the terminal Fed fund rate's going to be, which is a function of what you think inflation is going to be ultimately. Typically, the 10 year treasury yield peaks around the terminal Fed fund rate. If you think the terminal Fed funds rate's going to be about 4.6%, which is what's priced into the Fed fund futures market, then yeah, the bulk of the move higher is behind us. So around 4% or above is probably a good time to start extending.

On the other hand, if you think inflation's not coming down next year and it's going to stay stuck at around 4% say, then typically in order to get inflation back down to target in the past during high inflation periods, the Fed has had to get the Fed funds rate one to 200 basis points over the inflation rate. So if inflation gets stuck at 4%, which I think might be what Steve is expecting, then the Fed funds rate's got to go to 5% at least, maybe a little bit higher. In that scenario, you might be better off staying in the short end of the treasury curve and not extending quite yet. But it all depends on where you think inflation is going because that tells you how high the Fed fund's rate is going and that tells you how high the long end of a treasury curve is going.

Steve Chiavarone: I want to just add onto this point because you can't really make an equity call right now without understanding what's going on in the fixed income markets. And this duration call I think is absolutely critical. When do you lengthen your duration, when do you think you've hit the terminal rate, et cetera, cetera? And I think one of the things to keep in mind is the market is obsessed with this concept of a Fed pause and then when they start cutting. Well, Feds generally pause about six months before the start of a recession and markets tend to bottom about one year after the first rate cut historically. And so our comment about patience, about this is going to take longer I think is about exactly what we're talking about.

I can't expect bonds to start rallying until I've seen a peak in inflation. And it isn't until bonds start rallying and I start being able to get inflation down enough that the Fed can cut, that I can really start get aggressive on the equity side. And so we've dealt with severe downturns. I think what makes this one different and what's confounding both the bond and the stock market right now is that this one may very well be defined by its duration and this is a longer period of economic blah for lack of a better term.

Linda Duessel: I've been curious really for quite some months as to the risks that were showing itself, the volatility that were showing itself in both the currency and the bond markets but the RLN Volatility Index doesn't seem to be able to make its way towards 40. And I don't know about you, Steve, but in my travel, people keep asking me, 'What should I buy?' Where is the fear in the stock market?

Steve Chiavarone: Yeah, I don't think stock only investors appreciate some of the financial market risks because they're really bond risks. I'd like to say having grown up in the equity world that the crises don't start in the equity world. They start in credit, they start in the bond world. I like to think about it this way. If I go onto a roller coaster and I get sick, I'm mildly annoyed. If I go to a theme park and I go on the merry-go-round and it goes too fast and I get sick, I sue the park. And I think what you're seeing right now is tremendous volatility in what's supposed to be the world's safest assets, which are sovereign bonds. And so anytime you're taking on leverage, you're generally holding as collateral a sovereign bond, whether it's a short term T-bill or a long term treasury or a gilt in the UK or whatever jurisdiction you're in, you're not expecting those instruments to fall 20-30%.

The 30-Year Treasury is down in excess of 30% this year. And so when you're thinking about the risk models that financial institutions, they're not expecting that collateral to fall to that extent and you get margin called. And I think that's what's happened in the UK. They got margin called because their collateral deteriorated in terms of value and that's a risk. And I think it's a risk that's out there in the market that's not totally appreciated by equity only investors because it's kind of foreign to them. I think if something breaks, that'll get priced into the VIX very, very quickly. And there's a game of chicken. The Fed's trying to break the back of inflation and get that bond market to rally before you cause a financial accident. Because the alternative, which is the kind of stimulative measures that the BOE have employed, aren't working, right? Rates are right back, higher than they were before the intervention. So you've really got to get this inflation under control or else the risk of a financial market accident increases.

Linda Duessel: So Don, here's Steve telling us that the stock market investors, they just don't really appreciate the risks out there. They're not watching what's going on with the rest of the world. I mean the bond market was always so boring. It was always so very, very boring. And this has been an historic year. If TINA was our mantra, there was no alternative but to invest in stocks. And now Steve is warning us that we're being Pollyannish over in the stock market. Is there any chance that maybe there's no...? Or alternatively, that we should be buying the US government bond market because it's gotten crushed after this historic year? What do you say?

Don Ellenberger: In nine of the last 14 years, Linda, the Fed funds rate has been zero. Money was free, cash was trashed. But you're right. Today, one year treasury bills yield 4.25%. Treasury bills are sexy again. So investors finally have a safe alternative to stocks and bonds that at least pays them something on a nominal basis if not after inflation. I mean you're right about TINA. TINA, there is no alternative. You have to buy stocks and high yield bonds. Well, TINA really is dead because cash is now an attractive, stable, and investible asset class, particularly, as Steve pointed out, when bond and stock prices are experiencing head spinning volatility and when the risk free rate is rising, that raises the bar for the minimum return on other asset classes and that's a headwind to both stocks and bonds going forward.

Linda Duessel: So cash is not just king, he's a sexy one.

Don Ellenberger: That's exactly right.

Linda Duessel: That's what I think I heard you just say. Now Silvia, I'm not feeling very bullish about your answer to these two questions, but there's been a lot of damage done in Europe and in China, two major regions of the world that we might invest in and for different reasons that we're all well aware of. Is either one of the investible in your view today?

Silvia Dall'Angelo: ell, it depends on the time horizon I guess meaning that I think there will be more pain in Europe as Europe is struggling to achieve energy independence and resilience. Also, Europe is struggling with the usual institutional challenges and clearly needs more integration at the political level to make sure that the currency is strong. It needs like a safe euro asset and clearly we are still quite far from that, but I think that we are heading in the right direction and as a matter of fact, this crisis could actually be a trigger to excite some positive developments also on the integration side and more, I'd say materially, on the energy side.

So Europe has now invested more in renewable sources and in the medium terms, so three to five years down the line, we might see a strong Europe in terms of energy resilience but also in terms of moving towards its target of net zero. So again, there will be more pain in the short term. It would be a painful transition. But longer term, that should pay off. And so for an investor with a longer term horizon, Europe, which is quite cheap, I'd say this day could be a good bet.

Linda Duessel: And China?

Silvia Dall'Angelo: Well, as I said earlier, I'm a bit more cautious with respect to China. There are some long term structural challenges for the economy. Of course, as I mentioned earlier, the property sector, but also I'd say regarding a transition from a middle income economy to a more advanced economy. And it's not obvious that China has all the features in terms of human capital and investment in productive human capital in order to get there. Of course, I mean Chinese policymakers might take the right decisions going forward, but as of now, I'm quite cautious about Chinese growth in the next few years.

Linda Duessel: Why cautious? So I've seen the acronym TINA, TINAC, there's no alternative country than investing here in the US. Silvia, I'd like to ask you from your perspective where, now with all the discussion we're running, we're quickly running out of time here with our guests, is where would you suggest internationally? I want to invest now, what should I do?

Silvia Dall'Angelo: Well, it's a very tough one. As you said, clearly the US economy is outperforming the rest of the world and so it still looks attractive in relative terms, at least in the short term. Of course, in a longer time horizon, as I said, Europe might prove a good bet. As I said, it looks quite cheap right now. And of course once these headwinds from a stronger dollar emerging markets, which of course are very complex and varied set of countries, might also offer some opportunities to diversify, I'd say.

Linda Duessel: Well, yeah, that's actually very, very good advice and diversification is job one and we can't really tell for sure what the future holds so it might be interesting to put your eggs in that. Back to Don, I'm sure I don't need to ask you. I think you've made very clear your views and how cash is looking attractive now for the first time in quite a very, very long time. Definite deserves some sort of a place. Before we say goodbye, I'd like to ask Steve one last question. I know that your team also puts together a recession dashboard and that you have been working with quite, I think, might be the longest lived alive of the dashboards that you offer. What is the recession dashboard telling us in terms of, 'We're in a recession now, it's likely to start when,' that sort of a thing?

Steve Chiavarone: There are several indicators that are kind of on the verge here. So unemployment claims at one point had risen sufficiently, they'd come back in a little bit. Credit spreads, particular high yield spreads, they got basically to 600, which is kind of what you'll see before a recession. Not in a recession but before recession. They've come in a little bit. ISM is teetering. And so I think it paints a very similar picture to what Don had mentioned earlier, which was an economy that certainly had some weakness in the first part of this year but that's not the recession we're talking about. We're talking about a consumer and kind of housing led recession and we're not quite there yet, but you're certainly moving in that direction. And if I may, I'll just say this because this has been a very bearish discussion, Federated is historically a very bullish shop.

The bull has not lost its horns here. I think the bigger picture here is that we think that the Fed will crush this inflation through a recession in '23. And when you're on the other side of that, you may be in a scenario, and I think we likely will be in a scenario where you can buy growth stocks between 16 or 18 times, not 30 or 31 times, and you can buy cyclicals down 40 or 50% off of their peaks. Those are attractive entry points. I don't want to put any words in Don's mouth, but I also suspect that at the end of that recession, you may see some really attractive nominal yields on credit instruments, high yield bonds.

If you've got a two or 300 basis point 10-year with a spread of a thousand basis points, when was the last time you could load up on a high yield bond with nominal yield at 12 or 13%? And so I think there's generational and career defining buying opportunities that are coming. The risk is that because all of our downturns have been so short in recent years, that you jump the gun too soon and you're not patient enough. And I think patience and humility are what you're hearing from us. And I think those virtues are likely to be rewarded in the weeks and months to come.

Linda Duessel: Well, that's a great way to end our hour today, and that is it for our time for today. I wish to thank you very much, Steve, Silvia, and Don for your insights today. And thank you all to the attendees for joining us. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes Here & Now podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Here & Now episode plus our other series, Amplified and Fundamentals for a global perspective on the issues, challenges, and trends shaping the investment landscape. I also encourage you to subscribe to our Insights email updates for the latest market commentary from the many great minds of Federated Hermes and follow us on LinkedIn and Twitter.

Disclosures: Views are as of October 11th, 2022 and are subject to change based on market conditions and other factors. This should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. High yield, lower rated securities generally entail greater market credit/default and liquidity risks and may be more volatile than investment grade securities. International investing involve special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging markets' securities can be significantly more volatile than the prices of securities in developed countries and currency risk and political risks are accentuated in emerging markets. Stocks are subject to risks and fluctuate in value. Yield curve is a graph showing the comparative yields of securities in a particular class, according to maturity. Securities on the long end of the yield curve have longer maturities. Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations. WTI, West Texas Intermediate tracks crude oil prices. P/E is priced to earnings ratio. BOE is the Bank of England. The Institute of Supply Management or ISM Non-Manufacturing Index is a composite forward looking index derived from a monthly survey of US businesses. Beta analyzes the market risk of an investment by showing how responsive the investment is to the market. Federated investment management company.