Macro Insights Weekly: Central bank resolve and the global economy
- The Fed is keen to underscore that its responsibility to deliver price stability is unconditional
- We expect below-trend growth and no Fed easing through 2023
- Global growth will likely slow by 300bps this year
- A non-trivial risk scenario is that the Fed hikes past 4% and a global recession ensues…
- …accompanied by sovereign and corporate sector stress, and sharp financial market correction
Commentary: Central bank resolve and the global economy
“Reducing inflation is likely to require a sustained period of below-trend growth.”
— Fed Chair Powell, Jackson Hole Symposium, August 26, 2022
The annual Jackson Hole Symposium is typically used by academics and Fed officials to explore broad topics such as the structure of the economy and the challenges of conducting monetary policy under uncertainty. But last Friday’s remarks by Fed Chair Powell were striking for their narrow and direct focus on the near term. The short and blunt speech resulted in the US equity markets selling off by 3-4%.
The speech was aimed at underscoring the Fed’s resolve in moving its policy stance to a level that will be sufficiently restrictive to return inflation to 2%. This is a tall order, as evidenced by the still-strong labour markets and substantial underlying inflation pressures, and would likely require maintaining a rather tight monetary policy stance through 2023, a view that we have expressed for long. As the Fed Chair warned in his remarks that historical record cautions strongly against prematurely loosening policy, the fixed income market, during Friday’s trading hours, gave up on its bet that there would be rate cuts next year.
The Fed recognises that a lot of global inflation in the cycle is from the supply side, but it is also keen to remind the markets and economy observers that its responsibility to deliver price stability is unconditional. Moreover, it is well understood by now that on top of supply side factors, a chunk of current US inflation is the product of strong demand, which can be dealt with by the various tools at the Fed’s disposal.
Chair Powell’s bottom-line was clear; the Fed will work hard to keep inflation expectations stable, and if that requires slowing down the economy substantially by raising rates to well above the neutral rate and keeping conditions sufficiently restrictive for all of 2023, so be it.
Our global real GDP growth proxy estimates suggest an-already slowing growth environment, slowing from 6%+ last year to just over 3% this year, and another year of around 3% growth to come. Europe and the US will likely see less than 1.5% growth next year, even as China recovers from its Covid slump. Asean-5 economies, lagging the developed markets with pandemic-transition, will enjoy some rebound momentum this year, but that too will likely falter next year.
So far, this discussion has revolved around a baseline scenario under which (i) inflation eases next year, but not enough to warrant policy rate accommodation and (ii) growth slows around the world but with no recession. The risk case is that rates may well go higher (Fed Funds rate of 4%+), precipitating much lower growth and a particularly sharp sell-off in global asset prices. Further exacerbation of the situation in Ukraine, or a major skirmish between the US and China could compound this scenario.
Consequent stress points would span the DM and EM, in our view. Those with high leverage, sovereigns and companies alike, would likely struggle. Margins would come under pressure, driving down profits, credit risks would spike, and capital flows would turn volatile again. With little fiscal room available to offset the tightening monetary conditions, the global economy could be in for a rough ride next year.
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