Fed Hikes & Beyond: Is a recession looking imminent?

The 2022 US recession has become the talk of the town and the whole world is now talking about it. Finally, the US has a huge say in the world of commerce and business because of the size of its $23 trillion economy. The United States is home to the world’s largest financial market, but the economy is staring at a recession.

The market capitalization of US companies in the Global Top 100 has grown at a CAGR of 18% and 15% over the past five and ten years, respectively, and increased by 19% in the year to March 2022. However, the future looks bleak economy and thus affects the growth of companies.

Past growth is under threat as the US has already experienced two straight quarters of declining GDP growth. Price growth in the US has been high for several decades and will not be slowing down anytime soon.

While there could be supply-side issues that could lead to inflation, the Federal Reserve has a task at hand. A rate hike appears to be the Fed’s main weapon in bringing inflation down from around 8% to below 2% in the economy. The Fed has already hiked rates by 225 basis points in 2022, and on September 21-22, when the FOMC meets to decide on a rate hike, a rate hike of 75 basis points or even 100 basis points is expected.

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Rate hikes will also affect the larger population and economy. Fed Chairman Powell made it clear in Jackson Hole that the Fed currently has no plans to stop its rate hike cycle. He warned of further pain for individuals and businesses from rate hikes.

Tony DeSpirito, BlackRock Fundamental Active Equity Investment Team, wrote in a recent statement: “The Fed’s ability to raise interest rates and shrink its balance sheet in a manner that neither fuels inflation nor dampens economic growth will have a significant impact on the economy have market environment. We are not calling for a recession, but we are aware that the risks of a recession are increasing. If the Fed tightens too much, the result could be a recession. If it tightens too little, there is a risk of inflation. The ideal scenario runs in the middle, allowing for a soft landing at political transitions.”

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Also Read: Will the US Federal Reserve Target a 50bps or 75bps points hike at the September FOMC meeting?

A higher interest rate makes it more expensive for businesses and individuals to borrow. With a reduced incentive to borrow and invest in the economy, the impact on credit growth becomes visible over time. Corporate profits are falling, as are corporate margins, affecting stock prices.

Ray Dalio, founder, co-chief investment officer and member of Bridgewater’s board of directors, recently warned of a sharp 20% drop in share prices if US interest rates rise 4.5%.

Also Read: Stocks Could Drop 20% If Rates Climb Around 4.5%: Ray Dalio

The damage to the economy is real. “PMI and real estate data are deep in contraction territory, suggesting that 2023 earnings estimates are way too optimistic and need to be lowered further. The US stock and bond market remains overvalued,” said José Torres, senior economist at Interactive Brokers

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The only way the Fed can bring inflation down quickly is by raising interest rates high enough to reduce demand to what the economy can currently comfortably produce. But by keeping interest rates rising, the damage to the economy cannot be ruled out. BlackRock notes in its weekly commentary: “The US economy has already faltered. Now we see a recession in sight early next year. We estimate that 3 million more people would be out of work if demand fell by 2%.”

Once the contraction in the economy becomes more visible, the recessionary environment may not be far away. Will the Fed halt rate hikes after the damage is done and
The US economy is firmly entrenched in recession, which is more of a concern for economists and investors. The probability of a US recession in the next 12 months is currently about one in three. If the US economy slides into a downturn next year, there is at least one consolation: the contraction is unlikely to be deep, according to Goldman Sachs Research.

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