Economy is heading into the white-knuckle part of the cycle

Rosenberg pointed out that in the past 50 years, a market decline of 20 per cent has presaged a recession precisely 100 per cent of the time.

But Rosenberg – who thinks that the US economy has already entered recessionary waters – is far from alone in his gloomy prognosis.

HAS Wall Street Journal survey of economists has found that they’re now putting the odds of a recession in the next 12 months at 44 per cent, well above the 28 per cent they estimated in April, and the 18 per cent in January.

Indeed, as the WSJ noted, a 44 per cent recession probability is usually seen only on the brink of, or during, actual recessions.

Now, it’s not hard to understand why economists are becoming nervous as the US Federal Reserve embarks on an extremely perilous path.

The Fed is now hiking interest rates aggressively to curb inflationary pressures, but hopes to avoid triggering an abrupt slowdown in economic activity, and a sharp rise in unemployment.

The Fed’s task is made even more difficult because higher interest rates won’t dent demand for essentials – such as food and energy – where the inflationary pressures are most intense.

What’s more, because monetary policy works with a lag of around a year, US businesses and consumers are now battening down for a protracted period of rising interest rates, against a backdrop of stubbornly high inflation and stuttering faltering growth.

Because there’s little doubt that US economic activity is braking sharply.

Retail sales dwindled in May, as US consumers felt the squeeze from higher interest rates and higher food and petrol prices.

Meanwhile, the jump in home loan interest rates – 30-year mortgage rates have climbed above 6 per cent, from about 3 per cent in December – has caused activity in residential construction to brake sharply.

Confidence among US home builders – who face a steep rise in the cost of construction materials even as demand for new homes dwindles – has now fallen for six consecutive months.

Rising interest rates are also putting the squeeze on US consumers who are running up credit at an alarming rate, as their wages fail to keep pace with soaring prices.

Analysts expect that average US credit card interest rates will hit 20 per cent by the end of the year, at a time when consumers are increasingly dependent on credit to pay for food and petrol.

What’s more, the negative wealth effect will also act as a drag on activity, as households cut their spending to reflect the collapse in the value of their investment portfolios.

Analysts estimate that US rate hikes have already cut some $US15 trillion ($21 trillion) from the value of US consumers’ holdings of equities and crypto currencies, which will likely translate into a sharp retrenchment in consumer spending.

And this will crimp economic activity.

One closely watched gauge – the Federal Reserve Bank of Atlanta’s GDPNow tracker – which follows US economic data in real time – is now signaling zero growth for the US economy in the second quarter.

The US economy shrank at a 1.4 per cent annualized pace in the first three months of the year.

Weaker growth outlook

The weaker outlook for growth in the world’s largest economy has soured the mood in commodity markets.

In US trading, crude oil futures finished the week at $US109.57 a barrel, down by more than 9 per cent for the week, and well below the 13-year high of $US130 a barrel it reached in March, following Russia’s invasion of Ukraine.

Energy stocks are also feeling the pressure, with the Energy Select Sector SPDR exchange trading fund, losing close to 13 per cent on the week.

But other commodities are also feeling the pain. Copper, which is extremely sensitive to the outlook for growth, has tumbled close to 20 per cent since its peak in early March.

And the iron ore price has tumbled to around $US125 per ton, down around 20 per cent from the early March peak.

Interest rate markets are also bracing for a sharp economic slowdown. Yields on benchmark US 10-year bonds hit a peak of 3.5 per cent ahead of the Fed’s 75 basis point rate hike last week, but finished the week at 3.2 per cent.

This suggests that bond investors expect that slowing economic growth will force the Fed to abandon its rate hike plans in the face of slowing growth.

At present, Fed chairman Jerome Powell is trying to reassure investors that the Fed will be able to control rapid and persistent inflation, without driving the US economy into the ground.

“We are not trying to induce a recession right now, let’s be clear about that”, Powell said, adding that the Fed was still attempting to walk the fine line that would reduce inflation, while maintaining a strong jobs market.

But, he noted that “those pathways have become much more challenging due to factors that are outside our control”. These include the war in Ukraine, and factory shutdowns that are disrupting the supply of goods and commodities.

Still, investors are skeptical that the Fed has a credible map for achieving its goal.

According to its projections, the Fed expects inflation will return to 2.2 per cent by 2024 – down from 8.6 per cent at present. But it is hoping to achieve this with only a minor increase in the unemployment rate – which is expected to rise from 3.7 per cent this year, to 4.1 per cent in 2024.

What’s more, it is expecting US economic growth to come in at 1.7 per cent this year and next, before rising to 1.9 per cent in 2024.

Markets, however, clearly see this as a case of wishful thinking on the Fed’s part. They expect that the US economic growth will be a casualty as the Fed steps up its battle against inflation.

Real damage will come as a result of the wealth effect running in reverse. Households lost more in equities and crypto.

Equities are down $US12.5 trillion this year, down $US13.1 trillion from November’s peak. After rate hikes ahead, loss of wealth will be somewhere in the $US15 trillion to $20 trillion range.

Much worse than the $US6 trillion total decline in equity wealth from the bursting of the bubble at the beginning of the century.

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