Inflation, recession and interest rates: immediate prospects

September 2024 by Ana Carrisso

Summer has come to an end and, although the US spooked investors at the beginning of August with worse than expected employment data, we continue to think that the current risks to growth and inflation remain balanced. We therefore maintain a soft landing as our base scenario, although we now assign it an even higher probability, having gone from 40% to 55% in our latest review of the macroeconomic context. We also assign a 30% probability of recession, since we believe that the US economy is heading towards a scenario of slowing growth and some easing in inflationary pressures. In short, although the risk of recession has increased, it has not reached levels that make us uncomfortable, above all because we believe that the finances of consumers and companies remain healthy. 

Inflation – what is in store?

In global terms, we expect growth in the world's major economies to stabilize or fall slightly below trend. We also expect inflation to continue to converge towards the 2% target, or close to it, that central banks are aiming for. This forecast gives us the confidence to maintain a less cautious stance on the duration of the higher inflation scenario. Obviously, the trajectory of inflation will continue to be a key issue for us. Our perception is that it will continue to be persistent – or “sticky”, as it is sometimes described – but it will not rise, much less return to 2022 levels. In our view, the downward trend in inflation that we observed for much of 2023 appears to have stalled in 2024. Possibly, the difficult part of this process of adjustment by central banks will be the final stretch of returning to the target of around 2%.

What to expect from the Fed?

However, the rate cut cycle has already begun, albeit not uniformly. The European Central Bank (ECB), the Bank of England (BoE) and the Bank of Japan (BoJ), among other monetary authorities around the world, have already started their respective interest rate reduction cycles. It is therefore imperative to monitor the impact of the reversal of their policies on the trajectory of inflation, while waiting to see what the next steps will be. As I write this, the Federal Reserve is the only major central bank that has not yet begun its own tapering process. However, the market consensus is that the countdown has already begun, both because of the weak employment data released in September and because of what Jerome Powell himself said at the economic symposium held in Jackson Hole in August: “The time has come to adjust monetary policy.” Although Powell said the Fed will maintain its cautious stance, depending on the publication of macroeconomic data, the evolution of the outlook and the balance of risks, he also said, to leave no doubt, that the “direction to follow is clear.” At Fidelity, our macroeconomic team now believes that the Fed is likely to cut interest rates by 25 basis points respectively at the September and December meetings.

But there may still be some surprises in store...

That said, it is advisable to prepare for other scenarios. It is still impossible to understand the full extent of the risks currently emanating from the financial markets, and bearing in mind that there may still be surprises - particularly with the US presidential elections in November - we cannot, at this stage, rule out the possibility of more frequent and larger cuts (up to 50 basis points), should financial conditions become more restrictive. In this context, we continue to prefer US TIPS (inflation-linked bonds) over US Treasury bonds. We maintain our underweighting in public debt, preferring instead to hold positions in short-term credit.