US Recession Odds Soar, Leaving UK and European Rate Expectations Misaligned

Markets are still reeling, with the likelihood of a recession implied by the US market rising sharply compared to the UK or Europe. If the Federal Reserve follows through with the rate cuts that the market is anticipating, then current rates in the UK (Sonia) and Europe (Euribor) appear too high.

Although last week's employment data was the catalyst, the true cause of the sharp increase in perceived US recession risk was market positioning. As discussed earlier this week, if market volatility remains high and instability persists, the chances of a recession will significantly increase due to the potential for a negative feedback loop between the market and the real economy.

Rapid market movements often lead to mispricing, particularly at the extremes. While the US recession risk surged, the odds for the UK and Europe only increased slightly.

This disparity seems unsustainable. If recession fears in the US push the Fed to cut rates as drastically as expected, it's unlikely that the UK and Europe would only reduce rates to the extent currently anticipated by their markets.

The focus here isn't on recent comments from ECB President Christine Lagarde or upcoming UK CPI data. These factors are less significant in a scenario where the Fed is making steep rate cuts as currently predicted.

The current situation is unstable—either US recession odds need to decrease, or those of the UK and Europe need to rise. The market is still adjusting after recent turmoil, and it will take time for the mispricing, especially in UK and European rates, to correct.