- Sustained monetary policy tightening will eventually slow the US housing and labour markets
- Negative wealth effect through asset price corrections is already feeding through the economy
- We are therefore making substantial adjustments to our US growth outlook
- We now see 2022 growth to be no more than 1.5%
- We expect virtually no growth (0.3%) next year; a recession is on the cards
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Commentary: Higher rates; lower growth
Last week’s meeting with the US Federal Reserve’s Open Market Committee left risk sentiments subdued, to say the least. Given the Fed’s communication, we now expect another 75bps rate hike in the next meeting on November 2, followed by a 50bps rise on December 14, taking the end-2022 Fed Funds rate to 4.5%. It is conceivable that both economic and financial conditions will have tightened sufficiently by then to warrant a lengthy pause thereafter, but given the Fed officials’ eagerness to cool down the labour market, they may remain on the path of some additional tightening in Q1 as well. We are therefore penciling in 50bps of further rate hikes between the February and March meetings, but only with even odds.
The prospect of the Fed funds rate at 4.5-5% is unambiguously negative for the global growth outlook. Even without the Fed action, Europe is looking at a recession due to the war in Ukraine, and China is looking at a substantially weak growth dynamic given a variety of domestic factors, including the stress in the property market and regulatory pressure on the tech services sector. Add on top of that a sharp decline in USD liquidity and sharply higher US interest rates, the world economic outlook looks particularly precarious.
We will continue to adjust our global growth expectations on the back of forthcoming demand weakening in the US. Already, rising rates have pushed up US home inventories and reduced the number of real estate transactions drastically. Next would be decline in prices, although that is yet to materialise in the large US cities.
The Fed is focusing on the labour market, where the latest data still suggest no impact of higher rates so far. Vacancies and wage growth are still ample, and the unemployment rate, at 3.7%, is near historic lows. Friday’s jobless claims report showed both new and continued claims are in comfortable territory. The Fed’s work will continue, both on the rate hike and balance sheet normalisation fronts.
Monetary policy tightening will eventually slow the housing and labour markets; it will also dampen investments. Negative wealth effect through asset price corrections is already feeding through the economy. All this is inevitably negative for growth.
We are therefore making some substantial adjustments to our US growth outlook. We now see 2022 growth to be no more than 1.5%, compared to our earlier projection of 2%. We expect virtually no growth (0.3%) next year, as opposed to our earlier forecast of 1.3%. This means a recession is on the cards, which could well nudge the Fed into cutting rates in early 2024, if not earlier, especially if inflation fades.
Taimur Baig
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