The Federal Reserve has raised the Fed funds by 25bps, as widely anticipated, bringing the interest rate to 2.25-2.5%, on the cusp of what is considered to be in the proximity of a neutral monetary stance, and signalled its intention to raise by a further 100-125bps in the coming 24 months. The Fed members’ median projections suggest that real GDP growth is expected at 3.1% in 2018E, 2.5% in 2019E and 2% in 2020E: this is reasonable, given the current strength of indicators, but with downside risks, in our view, given the worsening trade disputes and the position in the business cycle.
The hawkish bias of the central bank is consistent with the positive data released recently, but does not change our view that the business cycle has turned and, thus, it is time to seriously consider the timing of the next recession. It is in line with the historical pattern seen in the US and in other countries, that the central bank in this phase keeps a positive view and usually carries on raising interest rates until inflation peaks, reversing fairly quickly thereafter as the recession becomes visible by then.
The average historical forecast mistake in real GDP projections one year ahead is 0.4ppts and close to 1.1ppts two years ahead – we have calculated these from the IMF World Economic Outlooks since 1995.
We are of the view that, beyond a further 100bps of tightening, the downside risks to GDP growth to the US become material, and that means that markets should begin to discount the risk of recession around the end of next summer, assuming no hard Brexit.