12 APR, 2023
By Matthew Benkendorf
Looking at the US, some of the main concerns for investors in recent months have been interest rates and inflation. Regarding interest rates, the Fed had more to go before the banking crisis. This crisis dampened confidence and put a break on the Fed’s path of interest rate increases and balance sheet unwinding as the key breaking mechanisms on economic growth to cool inflation.
This crisis of confidence in the banking sector has probably lowered the necessity of as many future interest rate increases. Looking at the current inflationary situation, I believe we are in store for more interest rate increases, but not many, maybe another 25 basis points or so. We are not in the prediction business, but considering economic growth data, we should be near the peak. However, a peak in rates doesn't necessarily mean an automatic reversal. I think the market and a lot of market participants are wishfully thinking about that. But I think that's a little less likely.
Investors need to remember that correcting the inflationary path requires patience and economic normalization. Interest rate increases are an effective tool, but they work with a lag, and it is going to take some time to see the impact of the previous interest rate increases on economic growth. Although inflation pressure has eased and is likely to come down to a more comfortable level, it will probably stay structurally higher than what people have been accustomed to.
Economies operate on confidence. The recent events in the banking sector are exogenous shocks that shake consumer confidence and corporate behavior, which impacts consumer behavior and triggers an economic slowdown. So, if you take the banking sector’s effect on confidence, on top of the underlying economic data, the trend pointing to a recession is increasing—however, more likely toward the very end of this year and into the next year.
I believe the banking sector is still well-capitalized, and the Fed has enough ammunition to deal with this issue. If the sector manages to win confidence, the recession risk will likely dissipate.
Investors should not ignore the possibility of external shocks in particular. One of the potential triggers is the raising of the US debt ceiling, which is currently being discussed in Congress. A failure to raise the debt ceiling, with all its consequences, could further hurt confidence, both in terms of corporate and consumer confidence. It could also be disruptive in terms of injecting more unnecessary volatility into capital markets that could act as another, aggressive dampener on growth.
We believe that given the uncertainties and contingencies, investors should favor well-positioned companies in sectors whose businesses are driven by clear and robust factors. The healthcare sector, for example, is quite predictable in terms of underlying trends and factors. The same applies to the consumer staples industry. Here, shares of manufacturers of high-quality consumer goods with pricing power and potential for long-term sales increases are particularly attractive. Select companies in both sectors are more easily able to pass on inflationary pressures.