Vantage Point: Investing for Alpha  

Why the outlook for the US economy has changed

Why the outlook for the US economy has changed

Markets continue to price in a scenario where the outlook for the US economy deteriorates next year and interest rates are cut, according to Jeffrey Cleveland, chief economist at Payden and Rygel. 

Cleveland said this was looking less likely  given that labour market data in the US remained strong and lay-offs had not increased.

He said: "That implies to me that rates will keep going up into next year, and then need to pause later in the year, but not be cut."

Article continues after advert

Rupert Thompson, investment strategist at Kingswood, agreed. He said: “The turmoil kicked off with the meeting of the US Fed last Wednesday. Its decision to hike rates by a further 0.75 per cent  was no surprise but its new forecasts put paid to any hope that rates were now close to a peak and would be lowered again any time soon.

"It is now projecting rates to rise to around 4.5 per cent by year-end and remain around here through next year, with any easing delayed until 2024.The Fed’s doubling down on its hawkish stance followed the inflation numbers of a couple of weeks ago which showed a worsening in underlying inflation pressures.

"Unsurprisingly, the Fed has cut its growth forecasts significantly given the additional policy tightening it is now planning, although it is still not predicting a recession."

Early in 2022, the US economy recorded two consecutive quarters of negative GDP growth, which meets the technical definition of a recession in most economies around the world. That negative reading was confirmed on September 29.

But the US does not use this definition and the designation of a recession is instead within the purview of the National Bureau of Economic Research. 

Cleveland believes the changed inflation data means the US economy will be able to “trundle along” in 2023, and mean there won’t be an incentive for the Fed to cut interest rates.

He said: "I think it would take core inflation to fall quite a lot, to say 0.2 per cent, for the Fed to consider cutting rates, and we are a long way from that."

One feature of the present monetary policy environment is the dollar, partly as a result of the rate rises, and partly as a result of its safe haven status continues to strengthen relative to other currencies.

This effectively exports inflation to Europe, because commodities are priced in dollars, so wherever they are bought in Europe, the price is higher. 

Cleveland says the issue facing central banks in the UK and Europe is that if the Fed continues to raise rates, policy makers must either try to match that to maintain the relative strength of their currency or accept higher imported inflation and try to crush inflation in the domestic economy.

George Lagarias, chief economist at Mazars, said: "Other central banks are compelled to follow to reduce the impact of a stronger dollar, further suppressing their own consumption. Meanwhile financial markets have become very volatile, as the search for the next market-friendly narrative remains elusive.