Bond and equity markets are arguing with each other. Bond markets see trade-war escalation, weak global data and declining inflation expectations. Equity markets see Fed easing, China stimulus and a trade deal with China ahead of U.S. President Donald Trump’s 2020 re-election campaign.

The bond market isn’t always right, and the equity market story has some appeal, but there is one heavyweight indicator on the side of the bond market – the inverted yield curve. This has predicted every U.S. recession over the past 50 years. The inversion needs to be sustained for a couple of months to provide a strong signal, but it makes a persuasive case for caution.

The Fed is now on track for one or two precautionary rate cuts. U.S. inflation is below 2% and market inflation expectations are low, which biases the Fed towards taking out some insurance against a downturn. The U.S. equity market is expensive and there is pressure on the cycle.

Europe is struggling to rebound from last year’s growth setbacks, although we expect there will be some improvement. The trade-war dominates, however, and optimism on Europe requires an easing in global trade tensions.

Not surprisingly, the trade-war also dominates the Asia-Pacific outlook. We see China stimulus and central bank easing across the region. Exports, however, are under pressure. Adding to concerns are that Japan seems likely to proceed with the October hike in the consumption tax rate. On the positive side, equity valuations in Japan and Emerging Asia are slightly cheap, but a positive view on the cycle requires confidence in a trade-war resolution.

U.S. business cycle index model have moved into the warning zone following the yield curve inversion. The model’s recession probabilities have not yet reached pre-2008 levels, but the readings are high enough to reinforce the note of caution that our qualitative assessment is providing at mid-year.