Firm in its fight against inflation, the Federal Reserve has strengthened its restrictive stance. International managers are wondering what can be broken before the central bank hits the brakes.
Far from predicting a turning point in its monetary policy, the last meeting of the Federal Reserve has consolidated a tighter monetary policy. During his speech, Jerome Powell borrowed a phrase from Mario Draghi: they will do whatever it takes. Except that in the case of the American banker, his fight is not to protect the euro but to reduce high inflation. Thus, we enter a new phase of the Fed. The motto: higher rates for longer.
The problem is data-dependency. Which currently demands this tough stance. “The outlook for inflation has worsened: of the three alarming data from the CPI in recent months, only 1 was known in June,” he defends Tiffany Wilding, economist for North America at PIMCO. In his opinion, inflation now looks stronger and more broadly based across all components of the CPI. For example, wage inflation has accelerated further and, in net terms, inflation expectations have risen.
an unavoidable pain
There are those who had among their cabals that the monetary adjustment cycle in the United States was close to a pause. But the September appointment has cast doubt on this thesis. “Powell avoided making explicit references to an impending recession, but made it clear that the Fed is willing to tolerate below-trend growth. and a weaker labor market while focusing on stifling inflation”, analyzes Silvia Dall’Angelosenior economist at Federated Hermes.
“Judging by the updated forecasts, the Fed has now recognized that some degree of pain will be necessary to bring inflation down to target and that the chances of disinflation without a major cooling in the labor market – the so-called immaculate deflation– are low”, believes Dall’Angelo. And so several managers agree. Paolo Zanghieria senior economist at Generali Investments, would also say that the Fed’s speech sounded much less confident in avoiding a hard landing. Who feel that a recession is the lesser evil compared to letting inflation take hold in expectations for a less aggressive stance. “The path to a soft landing is still there, but it is getting narrower,” he adds. James McCanneconomist in abrdn.
And it is that the numbers do not come out for a forced landing. As Sonia Meskin, an economist at BNY Mellon IM, points out, raising rates by almost 450 basis points in a year, but preventing unemployment from rising by more than 100 basis points, is a very challenging task for the central bank. One that history has shown has little chance of success. Y Andrew Mullinerby Janus Henderson, agrees: “The Fed’s unemployment and growth projections look optimistic given the degree of monetary tightening, but only time will truly tell to what extent this is wishful thinking”.
Interpreting the new era of inflation
“I think it’s fair to say that a forced landing is inevitable and we will see some type of economic contraction when moving to the next phase of the cycle”, he acknowledges Eva Sun Wai, fixed income manager of M&G Investments. What throws him off a bit is the Fed’s determination to commit to the 2% inflation target;. “It seems that, at least in the medium term, central banks they might need to revise their targets upwards to take into account the more rigid elements of the CPI baskets, and accept that we may be entering a phase of perpetually higher inflation than what we were used to in recent decades”, he says.
In your opinion, it seems unrealistic to aim for the same 2% target, given the post-pandemic global tightening cycle, huge ongoing supply chain disruptions (which turned out not to be “transient”), and a war in Ukraine. “Monetary policy also tends to operate with a considerable time lag“, the Mint.
And it is also the concern shown by several managers. That just like central banks were slow to react to inflation, now go too fast and don’t brake in time. For Jon Mayer, Director of Investments of Global X, the fear is that they press too hard. “There is a natural lag for higher rates to make their way into the economy. With mortgages now above 6% and expected to rise, more pain ahead for stocks, bonds and real assets is likely.”, he predicts.
Real estate: cracks in the Fed’s roadmap
Precisely the housing market is a point that indicates Thomas Costerg, economist at Pictet Wealth Management. “The high-yield debt market, vital oxygen to the economy, is already starved of lubricant, as is the mortgage-backed equity market, spilling over into the rapidly deteriorating housing market with significant ripple effect on the economy”, he highlights.
That is why we see managers who continue to believe that just as the Fed’s position corresponds to current data, it will have to change its discourse shortly. “The essence of risk management is the extreme risk aversion of an outcome, namely not reaching the inflation target, which mechanically leads to an overreaction to inflation,” he acknowledges. sebastien galyhead of macroeconomic strategy at Nordea AM.
The question being asked is whether this is the right move for future inflation given delays in monetary policy and a possible further rapid slowdown in the housing market. In fact, the scenario that Galy manages is that, after a period of relatively rigid inflation, households and especially companies will change their expectations and they will speculate on a possible recession that will cause inflation to fall rapidly.
“The Fed’s stance of We will do whatever it takes increases interest rate hikes and risks, which is likely to fuel volatility,” he says. Rob WaldnerInvesco’s Chief Fixed Income Strategist, The Fed is not turning to a more dovish stance, so Waldner would say now is the time to maintain a cautious positioning. And so it agrees from Mirabaud AM, who remain underweight equities with a bias towards defensive sectors, as it is too early to see a trend reversal in equity markets, with tightening underway.