“It’s oftentimes going to be the case that financial instruments and financial markets do fine until they don't.”

As things stand in early 2024, stocks are trading near all-time highs, US jobless claims have just plunged to the lowest level in more than a year, retail sales are still booming, and inflation is trending closer to central bank targets.

Having said that, Europe will find it hard to avoid a recession. Germany will probably be in one come April as may France. The UK looks set to narrowly avoid one, but in the US, they seem strangely optimistic that the economy will be able to engineer the proverbial soft landing in which inflation recedes without higher unemployment.

But according to Jason Cummins, the chief economist and head of research at the hedge fund Brevan Howard, the conventional wisdom will be just as wrong in 2024 as it was in 2023.

Brevan Howard manages around £17 billion and is famous for making money when others don’t. Two of its best years being 2008/2009 and 2022.

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In an interview with Bloomberg’s Odd Lots podcast, Cummins argues that we’ve already seen a very rapid slowdown in the labour market and that monetary policy is in an extremely restrictive place — a combination that will inevitably usher in the next recession.

The Fed, he says, is already “playing with fire” when it comes to the employment side of its dual mandate to maintain a healthy market and steady inflation.

“A very careful look at the labour market now will suggest that hiring has just ground to a halt,” Cummins says. “If it weren't for participation falling back by a huge amount — three tenths in the last report — the unemployment rate would've gone up by three tenths, to 4%.”

Meanwhile, household survey data on flows show that there’s been a big drop in the number of people moving into employment from outside the labour force, he says.

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Cummins’s comments feed into an intense debate about the future path of monetary policy and whether the current level of interest rates is high enough to continue tempering inflation without denting growth. Investors have been pulling back their bets on the speed and extent to which the Fed will cut rates this year following a recent spate of better than expected economic data. Markets are now pricing in less than 150 basis points worth of cuts in 2024, down from as much as 170 basis points earlier this year.

On the price stability side of the Fed’s dual mandate, Cummins sees a central bank that has massively overestimated the persistence of inflation, causing policy to become dangerously tight. He points to the Fed’s Summary of Economic Projections issued in June as a key starting point for the inflation miss.

“The median forecast for that 19-member committee was 3.9% for core PCE inflation,” says Cummins. Since then, the data has come in quite differently and Brevan Howard expects data out this week to show it will come in closer to 3% — a big miss in a span of just six months.

As such, Cummins argues that, given where inflation is and where the Fed is holding rates, monetary policy is historically tight and at a level that is typically associated with recession.

“In terms of thinking about where we’re going farther down the line, monetary policy now is as tight as it’s ever been on the precipice of recessions. If you take the Fed seriously, they think that long-term neutral is 2.5%. So rates are broadly 300 basis points above neutral. Whenever that’s been true, you've had a recession — with one small exception in 1984.”

Even with rates at their highest level in decades, US financial conditions remain relatively loose as stocks have soared to a fresh high and credit spreads have shrunk.

But, according to Cummins, financial conditions can be deceptive — and prone to rapid changes.

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“One of the times that I was the most bearish in Brevan Howard history was just after Bear Stearns was bailed out” on the eve of the great financial crisis in 2008, he says. “We thought the economy was absolutely falling apart.”

But it took the market awhile to get in sync with the real economy.

“If you look back at private payrolls, at that point you were losing 250,000 jobs per month in April and May after Bear Stearns failed,” and “stocks went right up, credit did fine,” Cummins says. “It’s oftentimes going to be the case that financial instruments and financial markets do fine until they don't.”

Outside of the near-term outlook, Cummins sees three huge shifts playing out in the global landscape, which he calls the three “ends.”

The first is the end of secular stagnation that characterised the post-2008 period. We’re not in a slow-growth, low-demand slump anymore. As such, the Fed still has to be mindful of fighting inflation, and the so-called “Fed put” — in which the central bank lowers rates and boosts risk assets when there are signs of a slowdown — isn’t in play the way it has been for years.

The second is the end of China’s existing growth model. Xi Jinping’s turn toward “common prosperity” and economic nationalism will change China’s role as a global growth driver and a global buyer of US assets, such as Treasury bonds.

The final turning point is the end of the “end of history.” For years, many assumed that liberal democracy was the clear winner in the global battle of ideas. But large swathes of the world are giving competing visions a second look.

“Surveys of the GlobalSouth — and if you don't trust the surveys, just look at what the leadership does, whether it’s Brazil or India, they’re not taking sides — they're seeing the dialectic between liberal democracy and illiberal tendencies. And they are not so sure about signing up with the post-Cold War liberal order.”

Of course, this matters because it could directly feed back into the inflation story.

“So now we face a genuine dialectic fight of liberal democracy against the forces that challenge it,”Cummins says. “And you might think, ‘Oh, well, you could say that at any time.’ This sounds like a political science podcast, but it has direct impact on financial markets because there’s one empirical regularity about wars: They cause inflation because they’re expensive to finance.”

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