With US labour markets still strong, the Federal Reserve is sticking to its “higher for longer” messaging. But the economy may see a shock next year when the effects of sharply higher interest rates come to bear, says Fidelity International’s Global Head of Macro Salman Ahmed.
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Why are central bankers intent on keeping rates high, or even raising them, when inflation is coming down?
The essential issue is that the labor market remains very, very strong. Yes, there has been a slowdown in the momentum of hiring in the US economy. But this is probably the tightest labor market we have seen in decades, so there is a concern in the background that inflation can come back.
The key central banks, including the Fed, made a huge mistake two years ago in underestimating the inflationary forces at play in the economy. As a result, there is an understandable cautiousness and lack of confidence in their own forecasts for inflation. And that is keeping policymakers on this mantra of higher for longer. They want to send the message that they are serious about bringing inflation down.
Why has the US economy held up so well?
There are multiple factors. Obviously, the Covid stimulus packages were very, very strong and we underestimated how long those excess savings would last.
At the same time, the corporate sector did a lot of borrowing at very cheap rates for the longer term during the Covid years. So now companies are earning interest on their deposits, but they are not yet paying extra for their debt. As more companies start to refinance their debt next year, things will change.
What is the path for inflation and growth from here?
The transmission channel by which higher rates have an impact on growth and inflation is delayed, not broken. So the economy will start to respond, especially on the labour market side, and that should start to put sustained downward pressure on inflation going forward. There will be a cost to pay in terms of growth and we remain in the recession camp for next year.
We have to watch the debt refinancing very, very carefully. Our own surveys show the majority of our sector analysts expect at least a 15 to 25 per cent increase in interest expenses for companies they cover. We need to think about the distribution of this increase in interest expense, whether it’s large cap versus small cap, or mid cap equities. In fixed income, you have to think about the default rates, which are starting to kick up.
Could inflation turn negative next year? And when will interest rates come down?
It depends on the extent of the hard landing we get. We think that structural inflation is likely to be higher going forward for the next 5 to 10 years...
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The cost of higher for longer (fidelity.be)
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