• Morgan Stanley sees a 27% chance of a US recession in the next 12 months, up from 5% in March.
  • Investment chief Lisa Shalett said slowing global growth and persistent inflation added to fears of a hard landing.
  • Shalett said volatility in the commodity, currency, and credit markets is another risk factor for recession.

Morgan Stanley says the risk of a recession in the United States is growing fast, as economic activity slows and inflation remains persistently high. In a note on Monday, the bank said the chances of a recession in the coming 12 months is now 27%, up from just 5% chance two months ago.

In her weekly note, Morgan Stanley Wealth Management's chief investment officer Lisa Shalett said investors have reversed track and increasingly started expecting a hard landing for the economy.

"The probability of a hard rather than soft landing in the next 12 months has jumped to 27%," Shalett wrote.

Shalett said surging inflation, at 40-year highs in the US, means the Federal Reserve must tighten monetary policy faster to tame it. Last week's consumer price index report – a closely monitored gauge of broad inflation – showed inflation had moderated in April, but by less than expected, casting doubt on economists' projections that consumer price pressures have peaked.

"It now appears that inflation is broadening out and has the potential to stay higher for longer. This is a scenario that places upward pressure on longer-run inflation expectations and keeps the Fed in a policy acceleration mode," Shalett said.

The Fed must now rein in inflation but without tilting the economy into a recession. The central bank raised interest rates by 50 basis points in May, the biggest increase at one meeting in 22 years to quell inflation.

Former Fed Chair Ben Bernanke said the Fed moved too late to clamp down on inflation, with economist Mohamed El-Erian also saying in a recent interview: "history suggests when the Fed is this late, the probability of a recession is uncomfortably high."

Several Wall Street banks are forecasting a recession in late 2022 or early 2023, as they say the Fed has fallen behind the curve and must act more aggressively to cool inflation.

Morgan Stanley's Shalett said the economy could slow because of demand destruction from sky-high prices. She added that another volatility in commodity, currency, and credit markets could be another factor that could lead to recession.

Regarding the current market conditions, Shalett said price action in the last six months had been "disappointing", with the worst annualized concurrent negative performance for both stocks and bonds since 1985.

"Consider remaining patient as the cyclical bear markets in stocks and bonds play out, keeping volatility high and returns constrained," she said.

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