Market Week in Review: Is the global economic expansion decelerating?
On the latest edition of Market Week in Review, Equity Portfolio Manager Olga Bezrokov and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the latest economic data releases and how central banks are reacting to the numbers as they seek to tame inflation. They also chatted about the timeline for a potential U.S. recession.
PMI surveys disappoint, while closely watched U.S. inflation gauge slows
Diving into the data with a look at recent purchasing managers’ index (PMI) surveys from the U.S. and the eurozone, Bezrokov said that the latest numbers came in below expectations, but were still above a reading of 50—the dividing line between expansion and contraction. “This deceleration wasn’t too surprising,” she noted, “as the latest actions by central banks have been taken explicitly for the purposes of cooling down an overheating economy in order to subdue inflationary pressures.”
Turning to the housing market, Bezrokov remarked that both U.S. housing starts and sales of new and existing homes missed expectations during April. “This is reflective of declining affordability levels among prospective buyers, who have been effectively priced out of the market by both high housing costs and the steep rise in mortgage rates,” she explained.
On the inflation front, Bezrokov said that the U.S. personal consumption expenditures (PCE) price index for April—the Federal Reserve (Fed)’s preferred inflation gauge—rose at a year-over-year rate of 6.3%. While the increase was a touch higher than expected, it was importantly less than March’s increase of 6.6%—making for the first deceleration in the index this year, Bezrokov said.
“Potentially, this could be an indication that the actions the Fed has taken so far to combat inflation, as well as the central bank’s communication around future actions, may be starting to have the desired impacts,” she remarked.
Overall, Bezrokov said that the key takeaway from all the data is that the global economic expansion is still continuing, but with growth decelerating from a very high rate. In addition, U.S. inflation appears to have come off its recent highs, but remains stickier than expected, she added.
ECB unveils plan for rate lift-off in July
Gilbert asked Bezrokov how central banks from around the world are reacting to the recent economic data releases, amid a global push to extinguish inflation. Bezrokov said most global central banks envision more rate hikes this year in order to restore price stability. This includes the Reserve Bank of New Zealand, she said, noting that the central bank lifted its benchmark rate by 50 basis points (bps) on May 25 and indicated many more rate hikes are likely down the road.
Meanwhile, European Central Bank (ECB) President Christine Lagarde recently revealed that officials will likely increase rates by 25 bps during July and September, Bezrokov noted. “This would allow the ECB to raise interest rates into positive territory by the end of the third quarter,” she said, noting that the central bank’s cash rate currently stands at -0.5%.
Shifting to the U.S., Bezrokov said that minutes from the Fed’s May 3-4 meeting show that most central bank officials see 50-bps rate hikes as appropriate at the next two meetings, which are scheduled for mid-June and late July. “The minutes showed that members of the Federal Open Market Committee are very concerned about the hardships high inflation is causing, as well as its persistence—and that they believe aggressive actions are needed to bring pricing pressures under control,” she said. Fed officials also flagged other concerns at the meeting, including risks to commodity markets from the war in Ukraine, she added.
The meeting minutes also revealed the impacts the Fed anticipates from this year’s rate hikes, as well as the path forward for monetary policy, Bezrokov noted. “Central bank officials saw the potential need to hike the policy rate into restrictive territory in order to meaningfully slow down the economy, particularly on the demand side, in order to rein in inflation,” she stated. Right now, the Fed believes that monetary conditions remain accommodative, with the cash rate below the neutral rate—and this is not where the U.S. central bank wants to be, given the risks around inflation, Bezrokov said.
The aggressive rate hikes expected at the next two Fed meetings would allow the central bank to slow down the economy quickly, potentially providing the opportunity for a pause in the rate-hiking cycle later on in order to assess economic developments, she noted. However, Bezrokov stressed that it’s still too early in the game to expect a pause in the cycle now, especially in light of ongoing elevated inflation.
Our assessment of recession risks
Bezrokov and Gilbert wrapped up the segment with a look at potential U.S. recession risks. Bezrokov stressed that a recession is not a concern in the short-term, but noted that it could become one down the line if the Fed continues on its projected aggressive rate-hiking path.
“The deceleration we’re seeing in the latest economic data is by design, and the Fed has been very clear that its number one goal right now is to slow down the economy in order to extinguish inflation—not to prevent a recession,” Bezrokov explained. That being said, however, recession risks aren’t today’s problem, she concluded.
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