A recession is coming. The world had made peace with that last year, but why does the current panic seem so fresh? Is it because the global economic downturn will be far worse than anticipated in 2022? Where is this fear stemming from?
The US, the world’s largest economy, is probably hurtling towards a recession sooner than expected and there is no end to the mixed messages and behind-the-curve action by the Federal Reserve. The fears spiked most after Federal Reserve Chairman Jerome Powell on March 7 said benchmark rates would likely go much higher than anticipated.
Despite raising interest rates to 4.5 percent in this cycle, the US central bank is clearly struggling to battle high inflation which indicates that the Fed may have to keep going higher before taking its pedal off the accelerator.
While Fed Chair Jerome Powell officially declared that the ‘disinflation process has begun’ after the January 31-February 1 meeting, the Personal Consumption Expenditures price index rose 5.4 percent — two and a half folds higher than the Fed’s target mandate, in January.
Rising inflation and slowing growth momentum remain a prime cause for a recession but there are external factors too.
‘2022 was a shocking year”, says Kalanovic of JPM. “this year has been remarkably turbulent, with the global economy hit by multiple adverse shocks — from supply and demand issues spilling into labour markets and a third major wave of COVID-19 to Russia’s invasion of Ukraine.”
Those risks combined with sheer uncertainty among central bankers about an economic recovery post the pandemic suggest risks of a deeper recession are skewed to the upside.
Nearly no one, not even the central bankers, seems to have a projection about the state of the world economy that they can reiterate six months later.
In 2020, rising inflation was declared as nothing more than ‘transitory’, a view that was echoed by Powell’s peers in the eurozone and the UK, those entrusted with the job of maintaining price stability allowed inflation to take such deep roots, that it might take that much longer to weed it out.
In November 2022, Powell again said it made sense to moderate the pace of rate increases as there was a level of restraint that would be sufficient to bring inflation down.
But that stance of smaller rate hikes evaporated quickly when Powell recently said the inflation fight will take 'a significant period of time' in February. This pattern is all too common in most major central banks in the developed world.
Although only a month back, the Fed was expected to raise rates by 25 basis points, the money market is now pricing in a 50 basis point hike in the next FOMC meeting in March.
Any rate hike comes at the cost of growth, and the steeper it is, the likelihood of a slowdown is that much higher.
Markets have not taken the news well.
Government bonds were hit hard and the yield on the US two-year Treasury note is languishing near four-month highs after inflation data came out stronger than expected. With the market trying to figure out if future rate hikes are adequately priced, the next batch of economic indicators is likely to be crucial.
"The surprises in January inflation releases have challenged hopes for a smooth return to target inflation," said Bruno Schneller, managing director at INVICO Asset Management.
He said that if inflation proved stubborn, central banks might be forced to raise rates further to stave off further economic damage. "Consequently, the risk of policy-driven recessions could rise," added Schneller.
In the last few months, thousands of jobs were lost triggering a global alarming situation. This sudden wave of unemployment has sent shockwaves throughout the job market and the labour industry.
While the US unemployment rate is still historically low, the effect of mass layoffs will probably be reported in the near future. For now, the Fed has to deal with one of its targets - inflation.
Essentially, if inflation shoots up further, the Fed will have no choice but to raise interest rates for longer. With higher borrowing costs, corporate earnings will be negatively impacted and so will be the investors.
But if the central bank doesn’t try to tame inflation, it’s the poorest of the people who will suffer the most. The whole situation suggests the Fed may be behind the curve and the dilemma that the Fed finds itself in goes back to the miscalculation in the early days of the pandemic.
First Published: Mar 6, 2023 6:42 AM IST
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