Vijay Kumar Gaba

Post the latest meeting of the US Federal Open Market Committee (FOMC), the market narrative is primarily focused on the following five points –

(i)      Whether the Fed is done hiking rates or it may hike once more in 2023.

A larger section of market participants believes that the Fed may hike another 25bps by the end of 2023 and then pause for 6-9 months before cutting the rates from 4Q2024. Another section is however of the view that the economic conditions are too tight to tolerate another hike. This section believes that the hiking cycle of the Fed may well be over and we may see rate cuts from 2Q2024 itself.

(ii)     Whether the treasury yields and other lending rates in the US economy will stay “higher for longer”, as forecast by the US Fed, or we shall see a faster decline, as the economic conditions deteriorate.

The higher rates have already started to reflect a slowdown in the US housing market. The rate of bankruptcy filings has also reportedly reached the 2008 levels. We have already witnessed one round of trouble in the regional banks, which was contained by the Fed support; but the fragility of smaller banks and pension funds remains pronounced.

(iii)   Would the US economy witness a gradual bottoming out (soft landing) or will it contract quickly into recession (hard landing) as the higher rates permeate through the economy?

The US Fed has reduced its balance sheet by over US$940bn since April 2022, while the US public debt has increased by ~10% to US$33trn in this period. A recession may prompt the Fed to unleash another round of quantitative easing (QE) through balance sheet expansion; whereas a controlled slowdown may permit it to further contract its balance sheet (QT).

(iv)    How would the “higher for longer” rates impact the US dollar?

In recent quarters, we have witnessed a tendency to reduce the USD treasury holdings amongst some of the major holders of the US treasury, e.g., China, Japan, and Saudi Arab. Besides, the percentage of USD invoicing in global trade has also come down. Some central bankers have increased their holding of gold, and cryptocurrencies have also gained larger acceptance. The question therefore is whether we are likely to witness a prolonged phase of USD weakness.

(v)     How would a softer US economy or a US recession impact the overall global economy?

The growth rate in the Chinese economy has been slowing down for the past many quarters despite frequent attempts to stimulate growth. Despite showing promise, the Japanese economy has not been able to accelerate its growth. Most major European economies are struggling to avoid recession. Some emerging economies, like India and Indonesia etc., have shown resilience; but a slower US economy could potentially have a more severe impact on the overall global economy, as compared to the global financial crisis period (2009-2010) when growth in emerging economies like China and India sustained at much higher rates.

I am too small an insect to comment on these larger global issues. Nonetheless, I retain the right to assess the impact of outcomes on my tiny portfolio of investments. I shall be happy to share my naïve thoughts on these issues that I will take into consideration in the next couple of years…more on this tomorrow.