Persistently high inflation has Wall Street fearing that the Federal Reserve will respond by raising interest rates until the United States plunges into recession, taking the sluggish global economy with it.
As analysts say the US economy grew in the third quarter, signs of trouble here and abroad are mounting. Higher Mortgage Rates Cool US Housing Market; Energy shortages harm German factory production; and recurring coronavirus lockdowns are hampering Chinese businesses.
The Fed and other central banks are cutting lending to fight historically high inflation, even as three of the world’s major economic engines — the United States, Europe and China — are sputtering. As the United States and other governments also reduce spending on pandemic relief efforts, the global economy is receiving less support from policymakers than at almost any point in 50 years, the World Bank said Thursday in a new report that warned of rising global recession risks .
“I see a bumpy road ahead,” said Daleep Singh, chief global economist for PGIM Fixed Income. “We are in a world where the shocks will continue to come.”
FedEx shares tumbled on Friday, dragging broader financial markets down after Raj Subramaniam, the parcel delivery company’s chief executive, said he expected a “worldwide recession.”
Meanwhile, according to Citigroup, central banks are conducting the most aggressive rate hike campaign since the late 1990s. This month central banks in Europe, Canada, Australia and Chile raised rates and the Fed is expected to do so for the fifth time since March at next week’s meeting.
Some economists fear that world central bankers are misreading the global economy in their rush to raise interest rates, just as they did last year – in the opposite way – when they insisted inflation would prove temporary would, and resisted the action. The cumulative impact of a simultaneous credit tightening in multiple countries could choke global growth.
“I don’t really feel that many or any central banks are paying much attention to how their policies affect the rest of the world,” said Maurice Obstfeld of the University of California, Berkeley, former chief economist at the International Monetary Fund.
The Fed’s rate hikes are driving the dollar higher against other major currencies, making imported goods cheaper for Americans while making it harder for people and businesses in other countries to afford products made outside their borders.
Big oil importers like Tunisia have been hit particularly hard as crude is traded in dollars. The stronger greenback is also hurting developing countries that have high dollar debt. As their local currencies depreciate against the dollar, more Turkish lira or Argentine pesos are needed to pay off debts.
Despite raising interest rates by two and a half points since March, the Fed has been unable to slow the economy enough to take the pressure off prices. On Thursday, initial jobless claims fell for the fifth straight week in the latest sign the job market remains too hot for the central bank.
Although a lot of hiring is good news for American workers, many economists have said unemployment must rise before inflation cools.
The Labor Department’s report this week that consumer prices in August were 8.3 percent higher than a year ago – little changed from 8.5 percent in July – disappointed investors.
Some analysts expect the Fed to continue climbing above the 3.8 percent level policymakers suggested in June to complete their anti-inflation work. On Friday, economists at Deutsche Bank said the Fed’s interest rate could reach 5 percent next year — about double current levels.
Wall Street firms like Oxford Economics said this week the Fed will hit the brakes hard enough to corral prices even if it sends the United States into a brief downturn.
“Prolonged higher inflation, more aggressive Fed policy tightening and negative spillovers from a weakening global environment will combine to push the US economy into a mild recession,” the company said in a note to clients.
Since 1981, growth in the US and around the world has been largely parallel, according to Citigroup research. In each of the four global recessions since 1980, the United States – which accounts for about a quarter of the world’s gross domestic product or GDP – slowed either just before the global economy hit a slump or simultaneously.
The IMF said this summer that the global economy was at risk of slipping into recession due to the aftershocks of the Ukraine war, the pandemic and inflation. The IMF’s alert followed a World Bank warning of the risk of global “stagflation,” a toxic combination of persistently high prices and anemic growth.
There is no official definition of a global recession, although the World Bank uses the term to describe a decline in global GDP per person. Some economists say that a broad contraction in a number of metrics such as industrial production, cross-border capital flows, employment and trade, or an economic slump involving a large number of major economies marks a true global recession.
“We have the US, Canada and Europe all in recession in the second half of this year and early next year. Whether or not to call this a global recession is in the eye of the beholder,” said Ben May, director of global macro research at Oxford Economics. “But we will go through a very weak phase. It will feel like a recession.”
The big concern is Europe, which is struggling to adjust to the loss of Russian natural gas supplies. Moscow responded to European sanctions after invading Ukraine by cutting natural gas supplies to Europe by around 75 percent, according to Barclays.
As energy prices soared, consumers and businesses across the continent felt the pinch. After years of keeping borrowing costs below zero, the European Central Bank has hiked interest rates twice since July in a bid to stem inflation from over 9 percent – and plans more such moves despite a sluggish economy.
“This is the most dramatic change of course since the global financial crisis. The energy supply shock is hitting them much harder than the US,” said economist Carmen Reinhart of Harvard’s Kennedy School of Government.
Some economists say a broader adjustment is underway. After decades in which global integration kept price pressures in check in the United States and other advanced economies, external forces are now fueling inflation.
Governments in the United States, Europe and China are encouraging more domestic production through subsidies and investment restrictions. Transforming global supply chains will cost more, as will efforts to accelerate the transition away from fossil fuels to combat climate change, said Dana Peterson, the Conference Board’s chief economist.
“The days of ultra-low inflation are probably over,” she said.
Global economic activity contracted in the second quarter for the first time since the pandemic began in 2020. If this slowdown turns into a full-blown recession in the coming months, traditional solutions will not be available.
With inflation hitting near 40-year highs in the United States, Europe, Canada and the United Kingdom, central bankers are keen to raise, not lower, interest rates – the usual antidote to sluggish growth.
In 2008, when an imploding housing bubble sparked a global financial crisis, the Chinese government emerged with a wave of nearly $600 billion in infrastructure spending, followed by years of generous funding from state-owned banks. The total bailout amounted to more than a quarter of China’s gross domestic product, far more than the United States spent on stimulus programs, according to a study by the Organization for Economic Co-operation and Development in Paris.
Chinese spending led to orders for factories in the United States and Europe, copper mines in Peru, and iron ore producers in Australia.
Today, China is grappling with its own problems – including a debt-ridden real estate sector and slowing export growth – ahead of a thorny Communist Party congress in October that is expected to grant Chinese President Xi Jinping an unprecedented third term.
The yuan has also fallen almost 9 percent against the dollar this year and is hovering near the symbolically important mark of 7 yuan per greenback.
“Chinese leaders are more reluctant to use leverage that they have used in the past,” May said. “China is less likely to be the donor of last resort.”
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