September Outlook
September 9, 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 been 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 was rife that the Fed will only hike its rate by a further 50 basis points. These hopes were quashed by a hawkish speech from Fed Chair Powell at the recent Jackson Hole gathering. The Fed is on record for wanting to see several sequential months of improvement in the inflation trends before considering any change in its stance.

The Bank of Canada, after hiking its key lending rate by a further 75 basis points, indicated that further hikes are coming. The Bank is concerned that inflation is becoming entrenched. The Bank of Canada stated that the economy remained strong and that wage increases were accelerating.

The ECB joined the tightening crowd, hiking its key rate by an unprecedented 75 basis points, while downgrading Europe’s growth prospects.

We expect the U.S. 10-year Treasury yield to expand, perhaps reaching 3.5%. Corporate bond yields will track government yields closely as credit conditions are still positive but as modest strains have emerged of late. Some widening from Treasury yields is likely.

Wage pressures are escalating and have moved to the 5% plus 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. Inflation indicators, such as break-even rates, have softened noticeably lately.

Already, the market has discounted several further rate hikes and thus markets 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 4% area will not affect economies unduly.

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