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Monetary tightening should dampen economic growth, but a recession seems unlikely this year—opening up opportunities in credit.
The global growth landscape accelerated last year amid COVID recovery and ample liquidity, but as is well known, strain in the global supply chain, labor market dislocation and surging demand contributed to a historic surge in inflation, with headline CPI rising to a four-decade high. At first, dismissing the price increases as “transient,” the Federal Reserve took a hawkish turn in its messaging and has committed to multiple rate increases this year, with similar positioning by the Bank of England and more moderate guidance from the ECB—transitions that remain unshaken despite market volatility triggered by the Ukraine conflict.
Today, fixed income markets are being heavily influenced by questions around the impact of shifting policy and whether it could move already decelerating growth into negative territory—with widening credit spreads resulting even as Treasury rates rise. Although retreating from peak levels, inflation is likely to run above central bank objectives, maintaining pressure on the banks to conduct an extended hiking cycle, but likely with softening overall interest rate volatility from here, given that expectations are consistent with what we consider likely outcomes. Although there is a high degree of uncertainty around growth, our view is that the U.S. and globe can avoid a recession this year, with positive implications for a range of risky assets.
In assessing the current climate, we have structured our ideas around four dominant themes, which we explore at a high level in the rest of this quarterly.
What do we expect for U.S. inflation? We agree with market consensus that inflation measures will start to decline as some key drivers of higher inflation, particularly car prices, start to moderate. However, we think the declines in inflation will be shorter-lived and shallower than Street expectations. The key reason is housing inflation; we expect persistent levels in this area as well as pressure from wages on other goods and services. As a result, we believe inflation could easily remain at 3% or more throughout the year.
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