August 11, 2022 | By Hank Cunningham
The monetary tightening, only recently begun, is starting to impact economic growth prospects. In the U.S., GDP was negative for two consecutive quarters, accompanied by an inversion of the yield curve. These are traditional barometers of a recession. Global economic forecasts have tempered but are still positive. Housing markets have softened noticeably while commodity prices have endured a severe correction.
After the recent cooling in the CPI, speculation is rife that the Fed will only hike its rate by 50 basis points. It may be premature for such optimism, since the Fed is on record for wanting to see several consecutive months of improvement in inflation trends.
Consumer sentiment has ebbed but retail sales have held up. A major concern is whether capital spending is reduced or delayed. At the same time, the geopolitical landscape has produced widespread uncertainty, and even more inflationary pressure.
We expect the U.S. 10-year Treasury yield range of 2.50% to 3.25% to persist. Corporate bond yields will track Treasury yields closely as credit conditions are still positive.
Wage pressures are escalating and have moved to the 5% level and may prevent the inflation rate from falling back to 2%. Long-term deflationary pressures, such as demographics and technology, will re-emerge eventually and help ease inflation. Overall, inflation will be slow to subside, with most forecasts, including those from the central banks, estimating it to land between 4-5% this year.
It is likely that the Fed will be flexible in its monetary policy, owing to the uncertainty surrounding growth and geopolitical conflict. Already, the market has discounted several rate hikes and thus are not likely to react in a knee-jerk fashion. The Fed, and other central banks, remain committed to normalizing short-term interest rates in the belief that moving rates to the 3% area will not unduly affect economies.