Asset managers are now more convinced that the global economy is likely to enter a recession following the latest action by the US Federal Reserve, which raised its policy rate by 75bp to 3.0-3.25% during its latest meeting on September 21.

“The Fed’s own forecast of a mild recession may prove too optimistic,” says Aninda Mitra, head of Asia macro and investment strategy at BNY Mellon Investment Management. “The Fed’s own forecasts from the SEP (Summary Economic Projections) show the [Federal Open Market Committee – FOMC] expects to lower rates marginally to just under 4.0% in 2024.”

This assessment is echoed by other asset managers, including David Chao, global market strategist, Asia-Pacific (ex-Japan), at Invesco, who says: “It is becoming increasingly difficult for the US to avoid recession given the Fed’s forceful and rapid rate hikes. If you were to compare this rate hike cycle to previous rate hike cycles going back to 1983, the Fed has never raised rates this much in this short a time period.”

Although the rate hikes were expected, the Fed’s continuing hawkish tone indicates that more rate hikes are likely to come as it seeks to curb inflation which has remained high despite the aggressive tightening policy. This is the third consecutive 0.75% rate hike this year, which has pushed US interest rates to their highest level since 2008.

“The US economy needs to see a period of below-trend economic growth and rising unemployment rates for prices to start stabilizing,” says Pierre Chartres, investment director, fixed income, at M&G Investments.

Chartres says the likelihood of a soft landing for the US economy continues to narrow based on the FOMC’s SEP which indicate that the median forecast for economic growth in 2022 was lowered from 1.7% in June to a mere 0.2%.

“Given that economic growth in some sectors is already slowing rapidly, we remain wary of the risks that the Fed may overtighten monetary policy and create a more severe economic downturn than was maybe initially required,” he warns.

Fixed-income opportunities

For investors, this means more opportunities in fixed income, particularly in long-duration core bonds, as the short-term outlook for equities remains challenging, says Tai Hui, chief market strategist, Asia-Pacific, at J.P. Morgan Asset Management.

“The rate hike and the updated SEP support our emphasis on portfolio stability and a more defensive stance on asset allocation,” Hui says. “For Asia, the Fed’s outcome is also likely to keep pressure on risk assets in the near term, especially for export-oriented companies. A strong USD is also likely to persist. Asian central banks are already starting to tighten monetary policy (with China and Japan being the exceptions), and this should help to limit the extent of Asian currency depreciation.”

There may also be opportunities for investors in foreign exchange as the US dollar is expected to remain strong in the short term, buttressed by the Fed rate hike policy.  The strong dollar, however, is expected to present challenges to emerging markets.

The FOMC is expected to raise interest rates to 4% to 5% next year and is not likely to begin lowering until 2025.

In his comments following yesterday’s meeting, Fed chairman Jerome Powell characterized the Fed as taking “forceful and rapid steps to moderate demand” and that “there is still a way to go”. 

“Powell acknowledged that longer-term inflation expectations remain well anchored, but that he would like to keep it that way through this aggressive path,” says Chao. “And we are likely to see continued hawkishness from other major central banks such as the [European Central Bank], the Bank of England and the Bank of Canada.”