By Andrew Patterson, senior international economist, Vanguard.
Due to the rapidly changing environment so far, we have lowered our forecasts for economic growth in the United States and China and revised our views on inflation and monetary policy in the euro area.
We believe these economies will likely avoid a recession this year but see slower growth going forward because of a myriad of factors. Our forecast for Federal Reserve policy is unchanged.
We’ve revised our outlook for full-year US GDP growth to roughly 2%, down from around 3.5% at the start of the year1.
Behind our downgrade are three factors that will likely persist over the remainder of 2022:
So we’re tempering our expectations for US growth. This doesn’t materially change our views about the US labour market or inflation at this point. More moderate growth will keep the unemployment rate from falling below 3% in the near term, and high labour demand should normalise more rapidly.
We continue to expect that inflation will remain elevated but falling, supported by healthy demand, a tight jobs market and supply constraints that will linger on throughout the year. Persistently elevated energy prices have grown as an additional risk factor and we will monitor that closely.
The growth rate also doesn’t change our view on Fed monetary policy for what remains of 2022. Vanguard expects the federal funds rate to increase another 100 to 150 basis points (bps), on top of the 75 bps rise to 0.75%-1.0% seen earlier in the year.
The rate hikes will come alongside a continued reduction in the Fed’s balance sheet, a reversal of the quantitative easing seen in the preceding years.
The story is a bit different in the euro area. Our economists in Europe anticipate more interest-rate hikes in 2022 than originally forecasted. The European Central Bank (ECB) is now more focused on fighting inflation, which is spiking into double-digit territory on an annualised quarter-over-quarter basis.
The changing picture for Europe:
We’re predicting a 2022 growth rate just above 3% for China, which is lower than the consensus and considerably lower than the central government’s target of around 5.5%. Obviously, that’s still a healthy growth rate, but for China that will feel like a recession from what they’re used to.
The factors driving the downgrade:
Our revised forecast for the full year is a downgrade from the 5% we anticipated at the start of the year. It’s also lower than consensus views that generally range from 4% to 5%.
Although global recession is unlikely, things are in flux and the Federal Reserve will be watching indicators carefully when forming future monetary policy. The chart below reflects Vanguard’s modelling on how aggressive the US central bank would be in raising interest rates depending on various scenarios.
The federal funds rate in select scenarios
Notes: This figure describes the Fed’s rate hike path under each scenario presented. The forecasts are obtained from Vanguard’s model estimates. A combination of model estimates and subjective analysis is used to estimate the forecasts’ terminal rate and timing under each scenario.
Sources: Vanguard model estimates based on data from Refinitiv, Moody’s, and Bloomberg.
The Fed has to find a balance between reining in inflation and tempering the pressures of a tight labour market. Developments that weigh heavily on economic activity would likely cause the Fed to slow its pace of rate hikes.
Like the Fed, Vanguard will also be closely monitoring this ever-changing situation.
We’re always revisiting our views, in any economic environment. But the fact that we’re revising so many of our global perspectives now speaks to the uncertainty underlying today’s environment, given the risks surrounding geopolitics, policies and supply chains.
1 Measured on a Q4/Q4 percentage-change basis.
2 Imports are subtracted from GDP because they reflect goods produced outside the United States.
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