Analysts see substantial economic slowdown on horizon

Trading on Wall Street  credit: Andrew Kelly, Reuters
Trading on Wall Street credit: Andrew Kelly, Reuters

The surprisingly high US inflation reading for May has led to expectations of more aggressive interest rate hikes.

A turbulent week is expected this week on world financial markets, and in Israel as well. On Friday, the release of a higher than expected US Consumer Price Index reading, showing inflation running at an annual rate of 8.6%, sent stock indices sliding in New York. This Wednesday, Israel’s Consumer Price Index reading for May is due to be released, and later in the day the US Federal Reserve will announce an interest rate decision.

Bank Leumi chief economist Gil Bufman estimates that the US Consumer Price Index will rise by 1% in June, keeping the annual inflation rate at 8.6%. "This development in the inflation environment will affect expectations of interest rate hikes by the US Federal Reserve, and restores the possibility of a 75 basis point rise, whereas previous estimates spoke of a rise of 50 basis points in the next decision. In these circumstances, the Federal Reserve’s interest rate could reach 3% by the end of 2022, and continue rising to 3.5% by mid-2023," Bufman says.

What of the bond market? "As far as the effect on the bond market is concerned, we will see more of an effect at the short end of the curve, while the longer parts of the curve are more anchored in the basic real-world elements of savings-investment gaps.

"The rise in the Federal Reserve rate over the coming year could change direction later on, in the second half of 2023 and in 2024, especially if the economy continues to slow down substantially. The main effect is therefore to be expected at the short end of the curve and less on the long part, amid a flattening of the curve because of a rise in yields in the 1-3 year range. A flattening of this part of the curve could indicate a higher probability of a substantial slowdown in economic activity," says Bufman.

Psagot chief economist Guy Beitor believes that inflation will remain high for a while yet. "The story of this index reading is that the energy item continues to rise, at the same time as inflation is spreading and broadening in the service industries," he says. "The bottom line of the May CPI is that price rises in the US are broad-based and are continuing to accelerate, with the focus of inflation clearly shifting from products to services, and that is very bad news for the Fed, which will probably have to tighten policy significantly more than the market expected… We expect a substantial economic slowdown in the coming months."

Another point mentioned by Beitor is the political situation in the US. "We’re already in June, and in November there are elections to Congress, with polls already unfavorable (to say the least) to the Democrats, who, according to the polls, are expected to suffer a landslide defeat such as they have not sustained for eighty years. Pay attention to the political front in the US and to what the White House, and not just the Fed, could do in the coming months."

Avishai Karavani of Peilim Portfolio Management says that, fowling the release of the US CPI reading, "It can be presumed that the decision makers, among them the Secretary of the Treasury and the Federal Reserve chairperson, were very disappointed by the figures, as the working assumption on the basis of which decisions were being made was that inflation would start a process of moderation by the month for which the CPI was published.

"The implication is that the Fed has no choice but to continue raising its interest rate substantially over the coming months."

Published by Globes, Israel business news - - on June 12, 2022.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2022.

Trading on Wall Street  credit: Andrew Kelly, Reuters
Trading on Wall Street credit: Andrew Kelly, Reuters
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